The Roth do-over opportunity
In 2010, the tax laws removed the income limit on Roth IRAconversions. Because high-income individuals still can’t make regular contributions to Roths, the conversion option gave them their first pathway into the Roth universe. Because they provide tax-free growth for retirement savings, Roths are especially valuable to taxpayersin high tax brackets.But as I explained back in April, a big benefit of converting your IRA to a Roth is that you can recharacterize your conversion if things go awry. This offsets the downside of converting: You have to include the amount you convert in your taxable income and pay taxes on it. If the market goes down after you convert — as has now happened for many who made the move to a Roth late in 2010 — then you face the added insult of having to pay taxes on a higher amount than your Roth is currently worth.
Recharacterizing your Roth conversion lets you avoid that problem. In simplest terms, recharacterizing gives you a do-over as far as your Roth is concerned, letting you put your money back in the traditional IRA where it came from and pretending (for tax purposes) that nothing ever happened. Granted, you still have the losses from your investments, but at least you don’t have to pay taxes on them.
The only thing that does not change about your tax situation is that your tax situation will change.
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