Registered investment advisors who consult clients with retirement income rolled into IRAs will want to note an important deadline for undoing, or reversing, conversions of assets from traditional IRAs to Roth IRAs, and vice-versa.
According to the IRS’s website, the deadline for “re-characterization” of assets that were moved from one form of an IRA to the other is Oct. 15.
That means savings that were moved from a traditional IRA to a Roth in 2013 can be transferred back into a tradition IRA by the deadline, without incurring tax exposure.
Conversions are often reversed to avoid a tax hit, according to a post on Putnam Investments’ site.
When a traditional IRA is converted to a Roth, taxable income is created. That additional income may ultimately alter an individual’s tax exposure by moving them into a higher tax bracket — in which case it may be wise to undo, or reverse the original conversion.
Reversing a conversion to a Roth may also be wise when the investments have lost value after the original conversion, according to Putnam.
For example, the owner of a traditional IRA valued at $100,000 that was converted to a Roth in 2013 and that is now only worth $80,000 is required to report taxable income on the original value of Roth — meaning the $100,000.
In this case, undoing the original conversion will limit tax exposure, according to Putnam.
Distributions from traditional IRAs are, of course, taxed, though the original contributions can be written off. Roths are funded by after-tax contributions, and as such their distributions are not taxed.
One reason to move money from a traditional IRA to a Roth is that Roths are not subject to annual required minimum distributions, according to the IRS.
A Vanguard white paper suggests converting traditional IRAs to Roths before the required minimum distribution age can create tax advantages for retirees that don’t need to spend their minimum distribution.
“Converting to a Roth before the RMD age means paying taxes sooner, but the converted amount can remain tax-free throughout retirement and even when passed to heirs,” the paper’s authors wrote.
Vanguard’s research of its own clients shows that as many as 20 percent of investors who take a RMD move the money directly into another account, suggesting many retirees don’t actually need the RMDs to fund their retirement.