Roth Conversions and Recharacterizations

[Guest Wade Jackson]

I have a traditional IRA, and I converted a portion of it ($10K) to a Roth IRA about a month ago. As we are aware, the market has recently dropped, and of course, I wish that I had waited to do the conversion. I understand that if I recharacterize my previous conversion, I will need to wait until the beginning of 2005 before I can "re-convert". My question is: can I convert another $10K now (the new balance of my traditional IRA is well over $10K), and after this second conversion, then recharacterize my original $10K conversion back to the traditional IRA? This would have the same net effect of recharacterizing today and reconverting the next day. Are there rules that limit the number of conversion you can have in one year? If not, am I allowed to specify which conversion is being recharacterized? Any guidance would be appreciated. Thanks!

[John G]

Your question is pretty complicated.....

First, there are no rules governing how many times in a year you can designate some funds to be converted from an IRA to a Roth. However, I believe that one recharacterization starts to impose limits on your activity... perhaps one of our accountants will explain the details.

The Big Picture is ..... why go through all the turmoil? You did not provide all the facts so let me make some assumptions. You converted 10k and your tax impact might be 3000 for state and federal. If your Roth dropped in value by 20%, then it looks like the impact might be 20% of the 3000 or about $600.

Sure, no one wants to give up $600 but your time is worth something and your plan to recharacterize and then convert again has many possible flaws. First, you don't control the precise timing of the custodian transactions. Second, when you elect to convert again you may not be eligible. Third, you may find that your returned assets shot up and now you are paying the same or more taxes. Fourth, the Roth conversion program could get changed. And finally, your time is worth something! This seems like a lot of hoops to jump through for a modest savings, if everything breaks correctly.

OK, now for the Big Picture question. Exactly what were you investing the 10k so that you have such a big drop in 1 month that makes you contemplate the undo/redo? A markets move up and down, but rarely by so large an amount in one month to warrent your proposed transactions.

I would not sweat the small changes in any given month and focus on the overall concept of how I was investing, the risks I was taking, and the knowledge base on which I made decisions. Lets put my hypothetical $600 savings in perspective. You probably spend more than that on tuition for just 1 course. Or, its the cost of one "option" on a new car.... like those heated seats or the CD player.

My guidance to you is that your proposed changes back and forth are probably a distraction and that the time spent dealing with your custodian and the timing risks mean that you would probably be better off focusing on other issues.

[Appleby]

Under TD 9056, the final regulations for calculating earnings on excess contributions and contributions being recharacterized, it is provided that

In the case of multiple contributions made to an IRA for a particular year that are eligible for recharacterization, the IRA owner can choose (by date and by dollar amount, not by specific assets acquired with those dollars) which contribution, or portion thereof, is to be recharacterized.

This suggests that you could elect to recharacterize the first contribution, if you feel it is worthwhile after taking John's comments into consideration.

[Appleby]

As Barry Picker reminded me, it is even more practical to convert the second amount to a separate Roth IRA. This way, you can choose the Roth IRA that you want to recharacterize, and there is no need to bother with the complex calculation that is required to determine the earnings/loss on the amount being recharacterized.

See Barry’s article at http://www.rothira.com/recharacter.htm

TD 9056 is at http://www.irs.gov/pub/irs-regs/td9056.pdf