Do you regret your Roth IRA conversion?

Contributing to an Individual Retirement Account (IRA) has always been a popular retirement savings vehicle for the American taxpayer. IRA’s became even more popular with the advent of the Roth IRA in 1997. For those who qualify, Roth IRA contributions can be made on an after-tax basis (no tax deduction for the contribution). However, the accumulated tax-free earnings over the life of the Roth IRA can be pulled out tax-free during retirement assuming several rules are met. Because of the attractive tax features of a Roth IRA, many individuals contemplate converting their traditional IRA to a Roth IRA. Prior to 2010, only those taxpayers earning less than $100,000 per year were eligible to convert their traditional IRA to a Roth IRA. Beginning in 2010, the income limitation was removed and now taxpayers of any income level are eligible to do so.

Of course, there is a price to pay. The value of the traditional IRA upon the date of conversion must be reported as taxable income in the year of conversion and taxes paid on that amount at ordinary income tax rates. For conversions in 2010, the tax law allowed taxpayers the choice of reporting all of the conversion income in 2010 or spreading the income ratably over 2011 and 2012.

Many individuals who converted their IRA in 2010 may be wishing they had made a different decision. Maybe the recent market turmoil of 2011 has resulted in a significant drop in the balance of the now-converted Roth IRA, making it emotionally challenging to pay the taxes on the higher balance as of the date of conversion. Maybe paying the taxes on the conversion income proved to be too painful for cash-strapped taxpayers in this struggling economy. Whatever the reason, the tax laws fortunately allow for the ability to hit an “undo” button, or “re-characterize”, the Roth IRA back to a Traditional IRA.

Taxpayers that act by October 17, 2011, have a last chance to change the nature of their IRA contributions made for the 2010 tax year. This works as long as the 2010 return was filed by April 18, 2011, or a valid extension was filed and the return is filed by the extended due date. How do you go about “re-characterizing” a 2010 Roth IRA conversion? You can leave the money where it is now and instruct the IRA trustee to re-characterize the transaction, or, you can initiate a trustee-to-trustee transfer and shift funds from the Roth IRA account (the contribution to it, and any earnings on the contribution) to the traditional IRA.

These same rules can also be used to re-characterize a normal contribution to either a traditional IRA or a Roth IRA. Let’s use as an example where a person made a $5,000 contribution to a Roth IRA, when he or she could have instead made a deductible $5,000 contribution to a traditional IRA, and now the Roth IRA account shows a balance of $5,500. By re-characterizing the entire balance as a traditional IRA, the person is treated for tax purposes as if he or she made a deductible IRA contribution of $5,000 for 2010, and earned $500 tax-sheltered earnings within the traditional IRA.

Remember, though, you must make sure that the re-characterization is completed by October 17, 2011.

There is one other step. If you have already filed your 2010 return you will have to file an amended return for 2010. Doing so will generate a tax refund if you are (1) re-characterizing a Roth IRA contribution as a deductible contribution to a traditional IRA, or (2) re-characterizing a conversion from a traditional IRA to a Roth IRA. On the other hand, you may owe extra tax if you are re-characterizing a deductible traditional IRA contribution as a Roth IRA contribution. Although you must move quickly to initiate the re-characterization, you have time to file the amended return which must be filed by the normal deadline for amended returns, which is generally within 3 years.

Finally, a commonly asked question is “If I re-characterize my 2010 traditional-IRA-to Roth-IRA conversion then can I convert back to a Roth IRA at some later date?” The general answer is yes, however you must wait 30 days after the date of re-characterization before re-converting back to a Roth IRA. In fact, this represents a significant planning opportunity for those individuals who converted their traditional IRA to a Roth IRA in 2010 and subsequently experienced a significant drop in the balance of the Roth IRA. Such individuals can re-characterize the Roth IRA back to a traditional IRA, wait 30 days then, assuming the IRA balance is still low, reconvert the traditional IRA back to a Roth IRA and pay income tax on the lower value. However, the two-year spread allowed for 2010 conversions is not available for 2011 conversions, therefore careful thought and planning is necessary before implementing this strategy.

The decision to re-characterize either an IRA contribution or a conversion is not an easy one. There are numerous factors and assumptions to be considered. It’s not too late for individuals to call their trusted tax professional and re-examine their 2010 IRA contribution strategy and “change their mind” before October 17.


Chris West is a principal at Dalby, Wendland & Co., a full-service auditing and accounting firm that opened its doors in downtown Grand Junction in 1948 and is now entering its 63rd tax season. For more information about Dalby, Wendland & Co., including tax updates, visit
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Posted by on Oct 1 2011. Filed under Contributors. You can follow any responses to this entry through the RSS 2.0. Both comments and pings are currently closed.

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