This October marks the last chance that investors can undo — or recharacterize – a 2017 Roth IRA conversion.
Under the tax reform law, the process of reversing a Roth IRA conversion was repealed. The IRS provided guidance earlier this year to confirm that Roth IRA conversions completed in 2017 may still be recharacterized.
October 15, 2018, is the deadline for recharacterization of a Roth conversion that was made during the 2017 tax year. A recharacterization allows investors to reverse the action and move the funds back into their traditional IRAs.In the past, some taxpayers recharacterized the transaction if they decided the tax liability was too high or if it triggered other tax issues such as the taxation of Social Security benefits or exposure to the Medicare surtax on investment income. Others sought to recharacterize if the Roth IRA declined in value.
Conversion may be less expensive under the new tax law
Converting an IRA to a Roth IRA is a taxable event. Federal income taxes are due on the value of pretax contributions and any earnings. The reduction in marginal income tax rates under the tax law is lowering the cost for many investors who decide to convert traditional IRA assets to a Roth IRA.
Without the ability to recharacterize, more thoughtful analysis is needed before completing a Roth IRA conversion. Prior to tax reform, it generally made sense for taxpayers to convert IRA assets early in the year to maximize the amount of time before the tax-filing deadline and to determine whether to undo the conversion. Also, with the option to recharacterize the entire conversion or a portion, IRA owners were able to “guesstimate” how much to convert without being fully committed to that amount.
With the implementation of tax reform, it may make sense to wait until the end of the calendar year. This allows more time for taxpayers to determine their taxable income and the consequences of adding more income from a Roth IRA conversion.
Lastly, certain taxpayers in the 24% tax bracket may find a partial Roth IRA conversion makes sense. For married couples, this new bracket ($165,000 to $315,000 in taxable income) is significantly lower than the previous system, in which taxpayers would have paid either 28% or 33% on that income.
The decision to convert is complex. There are many uncertainties, including the future direction of tax rates, a taxpayer’s likely tax bracket in retirement, and the ability to pay the conversion tax with non-retirement funds. It is important to discuss the strategy with a qualified tax professional to understand how an IRA conversion may impact your financial plan.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.