As values in your clients’ accounts drop post-Roth conversion, they may be able to save on their tax bills by doing a Roth reconversion. Clients that did a Roth conversion will be taxed on the value of the converted amount at the time of the conversion. If the value of the account drops post-conversion, they may be taxed on an amount that is much higher than the value of the account at tax time.
The good news is that there’s a way to reverse the Roth conversion and reconvert at the lower account value, saving on income taxes in the process.
Before a Roth reconversion can be done, the Roth account must be recharacterized as a traditional IRA. The account can then be reconverted to a Roth account. The trickiest part of a reconversion is getting the timing right.
First, recharacterization from a Roth to a traditional IRA must be completed by Oct. 15 of the calendar year after the conversion. Second, an amount that was converted to a Roth and then recharacterized as a traditional IRA cannot be reconverted to a Roth in the year of the first conversion; you’ll have to wait until at least Jan. 1 of the next year. Also, you’ll also have to wait 30 days from the recharacterization before you reconvert from a traditional IRA to a Roth.
A lot can happen between the recharacterization and the reconversion, so you’ll need to decide whether you believe that the post-conversion losses in the account will stand until the reconversion can take place. If you recharacterize to a traditional account and then the account rebounds higher than its previous value, you’ll end up with a bigger tax bill. As a result, it often makes sense to wait to recharacterize the Roth until the end of the year.