If you have converted a Traditional IRA to a Roth IRA in 2014, you can reverse the conversion by doing what is called a Roth IRA conversion re-characterization. Under a re-characterization, the Roth IRA funds and assets are rolled back into a Traditional IRA and the amounts converted are considered contributed to the traditional IRA and you effectively cancel out the amounts converted. As a result of the re-characterization, the taxes that would have been owed for the Roth IRA conversion are no longer due and the assets and funds re-charaterized go back to a Traditional IRA.
A Roth IRA conversion re-characterization is an excellent strategy in two situations. First, if you do not have the funds to pay the taxes on the conversion. Reversing the re-characterization will remove the tax liability. Problem solved. Second, if the investments in your Roth IRA, following the conversion, did not fare so well and if the account decreased in value you are generally better off re-characterizng the conversion and going back to a traditional IRA and then conducting a new Roth IRA conversions at the lower valuation. If you have completed a Roth IRA conversion re-characterzation, you do have to wait until the next year to convert the same amounts back to Roth as the IRS restricts you from immediately re-converting after a re-characterization.
Here are a few keys facts to keep in mind for Roth IRA conversion re-characterizations.
1. You must coordinate the re-conversion with your IRA custodian as they will need to roll the Roth IRA funds back to a Traditional IRA. Your tax return also needs to properly report the re-conversion so that you don’t end up paying taxes on the 1099-R you will have received for the Roth IRA conversion.
2. You can re-characterize up to October 15th of the year following the year you converted. So if you conducted a Roth IRA conversion in 2014, you have until October 15, 2015 to re-characterizer the conversion. You have until October 15th even if you did not file an extension and even if you have already filed your tax return for the prior year. If you filed a tax return already and claimed the Roth IRA conversion amounts as income, the tax return will need to be amended.
3. Roth 401(k) or other employer in-plan Roth conversions cannot be re-characterized so once those are reported to the IRS you cannot reverse them as the rules applicable to Roth IRA conversion re-characterizations do not apply to 401(k) or other in-plan Roth conversions.
Because of the re-characterization rules, the decision to convert funds to a Roth IRA isn’t as “taxing” as you’d think as you can later have a change of heart if the odds don’t end up in your favor (e.g. lower investment value, or no personal funds to pay taxes on the conversion).
More details and information can be obtained from an informative FAQ page from the IRS here.
By: Mat Sorensen, Attorney and Author of The Self Directed IRA Handbook.