Deadline Is Approaching To UnDo A Roth IRA Conversion

by Hank Coleman

Roth IRA conversionsRoth IRA conversion has been all the rage this year with the lifting of income limitations by the IRS. But, not all mutual fund investors may be happy with the changes that they made. There is a little known IRS rule that allows mutual fund investors who converted to a Roth IRA last year but now want to change back to a traditional IRA to do so. But, there is a catch. Investors have only until this Friday, October 15th to reverse their decision and get back any taxes they paid.

What Is A Roth Conversion?

Tax law has recently changed this past year to allow anyone regardless of income level to convert a Traditional IRA into a Roth IRA. When converting a traditional IRA into a Roth IRA, you will owe taxes on the money you are investing in the Roth at the time of conversion because you are going from a before tax dollars plan to an after tax dollars retirement plan. This is potentially a great deal for an investor who believes that he or she will be in a higher tax bracket later in their life when the time comes to withdraw money from retirement accounts.

Why Would Anyone Not Want A Roth IRA?

You May Be In A Higher Tax Bracket

With the conversion, you may find yourself in a higher tax bracket the year you convert. Depending on a host of factors and your retirement planning assumptions, you may be better financially if you go back to a traditional IRA, where you will pay taxes in retirement when you withdraw funds. When discussing your individual situation with your certified financial planner, you may discover that your retirement income will be lower than expected. Then, you would be better off paying taxes after you retire than paying them now during a conversion.

Value Of Your Roth IRA Has Declined

If the value of your Roth IRA has declined sharply, you may want to consider changing your investment back to a traditional IRA. If you paid taxes during the conversion while your account balance was fat and happy, you paid more in taxes. You could pay significantly less in taxes at a later date on your declined account balance if you undid the Roth conversion, get back the taxes you paid, and then repeated the Roth IRA conversion at a later date paying less taxes on a reduced account balance. Currently, you are allowed to reconvert your account to a Roth IRA thirty days after you make the change or in the next tax year, whatever is later.

You Should Pay Taxes With Your Savings

You should usually only convert a traditional IRA into a Roth IRA if you do not tap your retirement accounts to pay for the conversion tax. You will lose a lot of future earnings if you have to do that. You should pay for your taxes out of your savings or other non-retirement investments. Reverting a Roth IRA conversion back to a traditional may be a great idea if you realize that you do not have the funds to pay for the tax bill.

All of the rules can be complicated. You should consult with a tax adviser or financial planner about which specific choice is right for you and how you can benefit the most. Roth IRAs have many benefits over Traditional IRAs, but they may not be for everyone. If your financial circumstances have changed or if the value of your Roth IRA has declined substantially, you may benefit from undoing your Roth IRA conversion.

(photo credit: Shutterstock)

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