Looking for a way to be smart and stay positive (at least from an attitude perspective) in the current market situation?
Now may be a good time to consider both sides of the Roth IRA conversion coin: if you did a full or partial conversion in 2010 and lost substantial market value afterward, you may want to recharacterize your conversion back to a traditional IRA; likewise, if you’ve delayed converting your IRA to Roth, you may want to consider converting for the 2011 tax year.
Recharacterization – “undoing” your Roth conversion – is an option to consider if the amount converted declined in value during the year. The deadline for recharacterizing a 2010 Roth conversion is October 17, 2011.
A unique tax planning option was offered to individuals who converted to Roth IRAs in 2010: taxpayers could spread the associated tax over 2011 and 2012. However, the decision to recharacterize gets tricky if you elect this option and only plan to recharacterize a portion of your original conversion. If you intended to spread the tax from your 2010 conversion over 2011 and 2012, the only way to do so if you recharacterize is to re-convert half in 2011 and half in 2012. There is some risk of re-converting at higher values with market volatility so high, potentially undoing the value of recharacterizing in the first place. Keep in mind if you recharacterize, you need to wait 30 days to re-convert.
Some of our clients converted to Roth IRAs during 2010. In response to the market’s volatility we recently compared the conversion amounts to the current values. The change in values since conversion ranged from approximately -6% to +5%. Because of continued market volatility, we found that it may not be valuable to consider recharacterization unless the converted amount dropped more than 10%. Although our ultimate recommendation for those clients was to not recharacterize their conversions, the exercise sparked meaningful and valuable conversations with our clients, allowing them to understand the strategic relationship between this tax “tail” and the investment “dog.”
With many accounts posting negative returns year to date, now may be a good time for a partial or full conversion. Taxes due from a conversion are dependent on a number of things including investment earnings and deductible contributions. Just make sure you have adequate cash on the sidelines for the tax bill due in April 2012.
We suggest you consult with your wealth and tax advisors if you are considering either of these strategies. For additional ideas, take a look at this interesting article.