When you convert from a traditional individual retirement account (IRA) to a Roth IRA, transferred amounts must be included in income if taxable when withdrawn (e.g., contributions and earnings in traditional IRAs and earnings in nondeductible IRAs), but are exempt from the 10 percent federal income tax penalty. Once the IRA is converted to a Roth IRA, qualified distributions can be taken on a tax-free basis. Thus, converting while values are low allows you to pay a lower tax bill and then withdraw the funds tax free in the future, hopefully after the values have recovered. No Income Limitation for Roth Conversions in 2010 and Beyond To use this strategy effectively, you need to decide when to convert. If you're in that situation, The transfer from the Roth IRA to the traditional You can recharacterize just a portion of the conversion. There are other situations where you might want to recharacterize.
To convert, your adjusted gross income (AGI) cannot exceed $100,000 in the conversion year, excluding any conversion amounts. There are many factors to consider before converting, but the ability to pay the tax bill with funds outside the IRA is a major advantage. (See right-hand box for an important future change regarding the AGI limit.)
Under current law, an individual with modified adjusted gross income (MAGI) above $100,000 cannot convert a traditional IRA into a Roth IRA. A law passed in 2006 eliminates the MAGI limitation, but you'll have to wait for a long time to take advantage. The favorable change will kick in starting with tax years beginning after 2009. For Roth conversions that occur in 2010 only, half of the taxable income triggered by the conversion generally must be reported in 2011 and the other half in 2012. For conversions in 2011 and beyond, all the income must be reported in the conversion year - as under current law. While you might want to keep this in mind when planning your portfolio, Congress could decide to change its mind later and eliminate this favorable provision before it ever becomes effective.
Taxes are paid based on your investments' value on the conversion date. If those values decline after you convert, you end up paying taxes on more than the current market value.
consider recharacterizing your conversion. For conversions made in 2009, you can recharacterize until October 15, 2010, meaning you can convert back to your original traditional IRA. Just make sure not to take possession of the funds.
IRA should be a trustee-to-trustee transfer. After the recharacterization, it is as if you did not convert, so you owe no taxes. If you already filed your tax return and paid the taxes, you might be able to file an amended return to get a refund. You can then reconvert your traditional IRA at a later date, provided your AGI does not exceed $100,000 in the conversion year. The reconversion can be completed at the later of 30 days after the recharacterization or the beginning of the tax year following the first conversion.
However, if you have several investments in the IRA, you can't simply choose the ones with the biggest losses for recharacterization. In that situation, a pro-rata portion of all the gains and losses in the account will be considered in the recharacterization. You can bypass this rule by setting up separate Roth IRAs for each investment. Then, if one declines substantially, you can recharacterize that one Roth IRA account, leaving the other accounts intact.
You might have converted to a Roth IRA, thinking your income for the year would be less than $100,000. If you later find out your income is over that threshold, you can recharacterize the conversion. Otherwise, in addition to the income taxes due, you would also have to pay a 10 percent federal income tax penalty and a six percent excise tax.You can also recharacterize annual IRA contributions. Perhaps you contributed to a traditional IRA, but find out your income is too high. You could then recharacterize to a Roth IRA contribution.
