Recharacterize Now!

Categories: Retirement Strategies

Large Roth IRA owners who converted from Traditional IRAs in 2010 should look at undoing those conversions through a recharacterization right away.

Many large IRAs were converted in calendar year 2010 to lock in the 35% federal tax bracket before the jump to 39.6% in 2011.  A Roth conversion at 35% is better than one at 39.6%, generally speaking.  The passage of the new tax legislation in December allows large IRA owners to get the benefit of the 35% bracket in 2011 and 2012.

Clients that did not utilize a valuation adjustment strategy prior to doing their conversion in 2010 now have the opportunity to take advantage of the significant tax savings potential therein by undoing those conversions now.  Assuming a 30% valuation adjustment, the effective tax bracket on large Roth conversions is reduced from 35% to less than 25%.

The deadline for recharacterization of a 2010 conversion is October 15, 2011.  Clients that recharacterize now may reconvert the same assets back to a Roth IRA after thirty days.  The rule is that a reconversion cannot be done until the later of thirty days post recharacterization or until the next tax year.

For example, a Roth conversion done in July 2010 that was recharacterized in October 2010 would have to wait until January 1, 2011 (the next tax year) to reconvert.  Conversions from 2010 that are recharacterized in 2011 before the October 15th deadline can reconvert after meeting the thirty day wait since they are already in the next tax year after the conversion date.

By recharacterizing now and reconverting thirty days later, clients start a new clock ticking where they have all the way until October 15, 2012, to watch the account and determine if the conversion should remain in place.  Prior to the new tax bill that kept the 35% top federal bracket, this strategy was generally off the table because clients would be reconverting in a higher tax environment.

Some cases may not warrant a recharacterization if the Roth assets have gone up significantly in value.  However, in most instances large IRA clients will be better off recharacterizing, applying a valuation adjustment strategy and reconverting.  The tax savings per million dollars of IRA value can easily exceed $100,000.  That’s real money and worth taking a moment to review those client cases!

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