Personal Finance

Money Matters: Advice for an investor looking to undo an IRA conversion

Q. Last year I converted a fairly large amount of my IRA to a Roth IRA. Now, due to the recent declines in the stock market, some of my holdings are worth considerably less than when the conversion took place. Do I still have time to undo my conversion? If so, please explain the process. If I can undo the conversion can I then reconvert while the stock market is down and therefore owe less tax on a 2015 conversion?

A. You have a little over a month left to undo your Roth IRA conversion. The technical term for “undoing” a conversion is a recharacterization of the IRA. You have until October 15, 2015 to recharacterize your 2014 tax year conversion. You have until this date even if you have already filed your 2014 federal income tax return, you will just have to file an amended 2014 tax return.

You can’t “cherry pick” which investments you want to recharacterize and you can’t immediately reconvert the same funds. If you don’t want to recharacterize the whole conversion amount, you can choose to recharacterize a portion. It would be nice if you could recharacterize only the investments that have declined in value but you can only select the dollar amount, not specific investments. You must wait until the beginning of the next taxable year following the year of the conversion, or if later, more than 30 days from the date of the recharacterization to reconvert the same funds. In your situation, you could reconvert anytime after January 1, 2016.

If you decide to recharacterize, contact your IRA custodian and tell them the amount you wish to recharacterize and the date on which you want this to take place. If you no longer have a traditional IRA or if you want to keep these funds separate, a new IRA will need to be established. The custodian will provide you with the necessary paperwork and then will make a non-taxable transfer from one IRA to another. You will receive a 2015 form 1099-R from the Roth IRA and a 2015 form 5498 for the monies going into the traditional IRA.

As discussed in a previous column, a recharacterization can also be useful if someone has funded a Roth IRA and then realizes they are over the allowed income limits. This would result in an excess contribution. Any excess contributions are subject to a 6 percent excess contribution penalty tax. The 6 percent tax applies to excess contributions for each year the excess contribution remains in the Roth IRA. It’s important to correct this since the 6 percent tax can add up to more than the contribution if left uncorrected for several years.

A person can recharacterize the excess contribution and any earnings from the Roth IRA to a traditional non-deductible IRA. Tax won’t be owed on any earnings since the transfer will be from one IRA to another. If at a later date one wishes to convert this IRA to a Roth IRA, income tax will be owed on the earnings but there will be no 10 percent early withdrawal penalty. If any readers made 2014 Roth IRA contributions and had a higher than expected modified adjusted gross income (MAGI), they may want to review the guidelines and determine if they need to recharacterize the Roth to a traditional IRA. For tax year 2014, if married filing jointly and MAGI is under $181,000 the full contribution can be made ($114,000 if filing single or head of household). If MAGI is $181,000 and less than $191,000 a reduced amount can be contributed ($114,000 and less than $129,000 if single of head of household). Based on a married couple with MAGI of $190,000 the maximum contribution limit if under age 50 is $5,500 ($6,500 if age 50 or over). See IRS publication 590-A for a worksheet to calculate reduced contributions to IRAs.