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How to Undo a Roth Conversion

| May 11, 2017

In the interest of rounding off our several part discussion on IRA planning opportunities, this week we are highlighting tax strategies involving a Roth IRA recharacterization.

The recharacterization of a Roth IRA occurs when a taxpayer elects to undo a Roth conversion by moving money that was previously transferred from a trad-itional IRA to a Roth IRA back into a traditional IRA, thus undoing the conver-sion.

Let’s take a look at how this may work. Assume that a taxpayer expects their income to be low in a given tax year. Therefore, they elect to convert funds from a traditional IRA to a Roth IRA to generate taxable income and take advantage of their low income tax bracket. However, when the taxpayer actually prepares their income taxes for the year in question, they realize they had more income than they expected. The additional income put them in a higher tax bracket, making the Roth IRA conversion an unattractive strategy for the year. In this case, the taxpayer can undo the Roth IRA conversion by doing a Roth IRA recharacterization. This will eliminate the tax due on the Roth conversion.   

The recharacterization option reduces the risk of a Roth conversion as it allows the taxpayer to reverse the conversion if they find it is not as beneficial as estimated. Taxpayers have until the due date of their tax return, including exten-sions, to engage in a Roth IRA recharacterization. Therefore, taxpayers could have until October 15th of the year following the year of the Roth conversion to undo the Roth conversion.