Tax Reform Targets Your Ability to Undo Your Roth IRA Conversion
By Sarah Brenner, J.D.
IRA Analyst
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Recharacterization is currently one of the few “do-overs” allowed under the tax code. Its days may now be numbered. The tax reform legislation currently pending in Congress would do away with recharacterization at the end of 2017.
How Recharacterization Works
Currently, if you do a Roth conversion, you have until October 15 of the following year to undo part or all of that conversion (and tax bill) for any reason at all. Recharacterization gives you a window of time to decide if conversion was the right move for you. While recharacterization is most commonly used to undo Roth IRA conversions, it also applies to Roth and traditional IRA contributions too.
Recharacterization Repeal
Tax reform proposals as passed by both the House and the Senate would repeal recharacterization and make conversions irrevocable. This would apply to taxable years after December 31, 2017. The ability to recharacterize IRA or Roth IRA contributions would also be repealed.
2017 Conversions
Usually, it is not a good idea to plan based on proposed law changes, but this is an unusual situation. If you converted in 2017, your time may be running out if you are considering recharacterizing that conversion. You may have been counting on more time, but if the tax reform proposal becomes law in its current form your deadline for getting your recharacterization done may become December 31, 2017 instead of October 15, 2018.
2018 and Beyond
Is conversion still a good idea after 2017 if recharacterization is no more? The benefits of a Roth IRA conversion remain unchanged. You trade a tax bill now in exchange for tax-free Roth IRA distributions down the road. That is still going to be a good deal for many people. What would be different without recharacterization would be that a conversion could not be reversed. That means you would need to be very sure than that it is the right strategy for you. The “do-over” option would not be available. More than ever, this would mean that you must carefully consider all the pros and cons before doing a Roth IRA conversion. It is more important than ever to discuss your situation with a professional advisor who is knowledgeable about retirement plan distribution planning.
Stay Tuned
At the Slott Report we are carefully watching all the twists and turns as tax reform makes its way through Congress. At this time, it is still very much a work in progress with provisions being added and taken away in committee. Stay tuned for the fate of recharacterization and for other changes that may affect your retirement plan.