Undoing a Roth Conversion

• Services
• Management
• Industries
• Career
• News & Information
• About
• Contact  

Undoing a Roth Conversion

Did you convert a traditional individual retirement account into a Roth IRA last year? And is the Roth now worth less than on the conversion date, thanks to the stock market’s erratic performance? If you answered yes to both questions, you’re stuck paying taxes on value that no longer exists.

But there’s another option. You have until Oct. 17 to reverse a 2010 Roth conversion. Then it’s like the conversion never happened, which means the inflated conversion tax bill disappears.

When you converted your IRA into a Roth account, the transaction was treated as a taxable distribution from the IRA. So the conversion triggered a federal income tax bill (and maybe a state income tax bill) based on the traditional IRA’s value on the conversion date.

For a 2010 conversion, you’re allowed to spread the resulting taxable income over 2011 and 2012 by reporting 50% of the income in each of those years. However, this deferral advantage doesn’t necessarily make paying an inflated tax bill a good idea.

Converting a traditional IRA into a Roth account can still be a great idea if you get the timing right. So, you might want to reconvert the reversed account from traditional IRA status back into Roth status.

Reconverting quickly makes sense if the account is loaded with assets you believe will appreciate quickly. That way, when all is said and done, you’ve still converted the traditional IRA into a Roth—But you’ve done it at a lower tax cost this time around.

There’s a timing restriction, however. For an account that was originally converted to Roth status in 2010 and then reversed back to traditional IRA status in 2011, you have to wait at least 30 days after the reversal date to reconvert.

Bill Bischoff/SmartMoney.com

Printed in Wall Street Journal September 11, 2011