Last week we explored whether you could convert your traditional IRA to a Roth IRA in 2018. This week, let’s go over whether you should “undo” that Roth IRA conversion in 2018. Again, the answer is: It depends.
What does it mean to “recharacterize” an IRA?
When you convert a traditional IRA to a Roth IRA, you include the value of your traditional IRA, reduced by any nondeductible contributions you've made, in your income for federal tax purposes in the year of the conversion. For conversions prior to 2018, if you subsequently decided to "recharacterize" or undo the conversion for any reason — e.g., the value of your IRA assets declined after the conversion, resulting in a bad tax deal — the IRS would permit you to do so, provided the recharacterization took place in a timely fashion. This is good financial news! In this case, it might be a good financial strategy for you.
For this tax tip example, let’s assume you converted a fully taxable traditional IRA worth $50,000 to a Roth IRA in 2016. You would have been required to include $50,000 in income on your 2016 federal income tax return. But shortly after the conversion, the value of your Roth IRA declined to $40,000. Suddenly you were faced with the proposition of paying taxes on $50,000, while your Roth IRA was worth only $40,000. There is good news! You have until your tax return due date (including extensions) to undo all or part of a conversion. So in this example, you would have had until October 15, 2017, to recharacterize or undo the Roth conversion. With this helpful financial advice, now you can get your financial planning goals back on track!
How did the Tax Cuts and Jobs Act of 2017 affect this?
Unfortunately, the Tax Cuts and Jobs Act passed in 2017 eliminated the option to recharacterize a Roth conversion, with one exception: If you converted your Roth IRA in 2017 and have since changed your mind, you have until your filing deadline, including extensions (or until October 15, 2018), to recharacterize. The time is getting shorter to make these types of sound financial decisions.
When you recharacterize, you need to withdraw the amount you originally converted, plus any earnings, out of the Roth IRA and transfer it back to a traditional IRA.
If you already paid your taxes for 2017, you'll need to file an amended return to obtain a refund for any taxes paid on the conversion. An amended return can generally be filed as late as three years after the original return was filed.
Undoing a Roth conversion can be complicated, so I think it’s imperative to consult your tax professional before taking action.
At Brighton Wealth Management, we provide the highest levels of personalized service, and offer continuous professional, independent and unbiased financial advice.
Please give me a call if I can assist you with any type of financial goal, or help you finish out 2018 with a strong financial portfolio.
Alan Battles is a Salt Lake City, Utah fee-only Registered Investment Advisor (RIA) fiduciary and financial planner. Brighton Wealth Management, Inc. specializes in providing objective financial planning and investment management to help clients build, manage, grow, and organize their assets during life’s transitions.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.
The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.