Roth conversion to maintain recharacterization flexibility
Here is real ife prospective conversion. I was hoping to confirm my understanding
Clent holds trraditional IRA with $60,000 in cash. He wants to purchase and hold one security. He can convert the $60,000 in cash from Traditional IRA to Roth IRA and then buy the security.
I thought it would be better if buys the security in the Traditional IRA and then converts to Roth. This would allow for recharacterization if stock value declines whereas $60k cash is $60k cash.
If 100% Roth is reccharacterized, the entire account including any realized dividends etc would be redirected back to the Trad IRA
Is my understanding correct?
Thanks in advance for any assistance.
Jim Magno
Permalink Submitted by Alan Spross on Tue, 2011-09-27 18:17
Jim,
It really does not matter much with respect to the order of buying and selling the investments. I would lean toward buying the single security in the TIRA first for the very minor reason that the commission will be paid from the pre tax TIRA funds. Then convert the number of shares of the security to equal the desired conversion amount. Now the Roth holds the single security, ie if the Roth account was newly created just for this conversion.
If recharacterization is desired, it does not matter what investment the Roth holds at the time. If the conversion is the only holding in the Roth a full recharacterization means the entire balance transfers back to the TIRA, whether it is still the security or whether the security has been sold and the Roth now holds cash.
If the security is dropping quickly in the Roth, it may be best to sell it since that can be done instantly. Then the cash goes back to the TIRA. If the security is held it could drop considerably more over the period of a few days it may take to order and complete the recharacterization.
A conversion can be done using a variety of strategies. One common strategy is to do 2 or 3 conversions to different Roth accounts with the intent of keeping the best performer and recharacterizing the others. If you want to make sure that you retain at least one of the conversions, invest one in cash or stable value investment that you would keep if the others lose money. That guarantees use of the marginal bracket for the year as opposed to the risk of losing all the conversions if they all dropped in value. But whatever the strategy, buying and selling within the Roth can certainly be part of it without making the recharacterization any more complex that would have been if there were no change in investments.
Permalink Submitted by JAMES MAGNO on Tue, 2011-09-27 18:42
Alan-
Thanks for the valuable feedback. The key is that the Roth account be separate from any other Roth accounts. As you noted, a common approach is to segregate Roth IRAs into separate asset classes. This helps to crystalize concepts that I do not deal with everyday.
Thanks much!
Jim