As the old saying goes, even the best laid plans can go wrong. So, what if you’ve done all of your research, assessed your financial future and gone ahead with a Roth conversion, only to see your assumptions fall apart?
Don’t worry. If this happens soon enough, you get an "undo" and recharacterize your conversion, turning your Roth back into a traditional IRA, or TIRA.
The nuts and bolts are simple. Call the bank, brokerage or mutual fund company that has your Roth and get them to walk you through the process. Generally, you have until Oct. 15 of the year following the one in which you did the conversion. If you were to convert now, you could undo the move as late as Oct. 15, 2011.
You don’t need to justify your move or present a case, but recharacterizations are typically done for one of three reasons.
Your Roth lost value. If you convert a $100,000 TIRA, you could be hit with a $25,000 income-tax bill, assuming a 25% tax bracket.
But what if a stock-market correction dragged your new Roth down to $80,000? Had the investment been worth only $80,000 when you did the conversion, the tax bill would have been $20,000, not $25,000. To make things even worse, converting $100,000 rather than $80,000 might have nudged you into a higher tax bracket.
By recharacterizing the conversion before the deadline, you could escape the $25,000 tax. Later, you could again convert the TIRA to a Roth. If the TIRA was still worth $80,000, the conversion tax would be $20,000, and the process would have saved you $5,000. To do the new conversion, you must wait until 30 days after the recharacterization, or until the following year, whichever comes later.