Hitting The Control/Alt/Delete Button on a Roth IRA

Roth IRA Life Planning TodayIn an attempt to make the best of a sour economic situation it’s time to take a look at your IRA or Roth IRA and try to make those sour investment losses you may have experienced over the last quarter work for you, rather than against you.

If you proactively took the opportunity to take advantage of the new 2010 IRA tax legislation and converted your IRA to a Roth IRA, you might be second guessing your decision. There was an impulse in 2010 to make conversions to a Roth early in 2010 so that individuals could pay taxes on a relatively lower market value and over a two year period, rather than a single year. If you jumped at the chance last year and invested in stocks or stock funds, you probably paid or still owe some taxes on an investment value that has declined. For example, if you had converted a traditional IRA with a value of $20,000 to a Roth IRA in 2010 and the stock market has decreased whereby your ROTH IRA market value is only $18,000, you still would owe taxes on the original $20,000 — which is doubly painful.

There is a faint light at the end of this tunnel; you have the ability to hit the control/alt/delete button and change your new Roth IRA back into a conventional IRA and recover the taxes you paid on the money that the stock market has compromised. The process of transforming a Roth back into a traditional IRA is called “recharacterization.” If you recharacterize and make use of your sour investments to cut your tax bill, you still will have the opportunity later to reconvert the IRA into a Roth IRA later in the 4th quarter of 2011; there is a 30 day waiting period.

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In addition, if you did convert your IRA into a Roth IRA but have been thinking about doing so, you might want to make the move this year when the market value of IRA may be relatively low. Unlike last year, you won’t have the opportunity to spread the taxes you will owe over two years because the two-year option expired at the end of 2010, which may be a good option. Although you will have to pay the full tax bill in a single year, the damage done by the stock market might have left you with a reduced overall tax burden.

Roth IRAs are an attractive way of saving for retirement and are even more powerful if you are concerned about the nation’s deficit and anticipate Uncle Sam might be primed to raise taxes before you retire. You will pay taxes on the money you invest in or convert to a Roth IRA in in the tax year for which you invest. The Roth will subsequently grow tax free and distributions will not be taxed provided you follow the rules and leave it invested until you are at least 59 ½ years old. In contrast, all distributions from a traditional IRA are taxed just like your income gets taxed now, at ordinary income tax rates.

If recharacterization is an option, you need to get the ball rolling. You have only until to Oct. 17 to recharacterize the IRA back to a Roth for the 2010 tax year. You will also need to finish the recharacterization by Oct. 17 if you are planning to file an extended tax return for the 2010 tax year.

Once your IRA is characterized as a traditional IRA, you can convert it back to a Roth IRA as long as you wait at least 30 days. You can also consider converting an existing IRA to a Roth.  Please do not hesitate to contact us; Ask Brad and Ann and we can advise you with your various options.

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