If you're considering converting a traditional IRA retirement account into a Roth IRA, be aware that the Tax Cuts and Jobs Act (TCJA) signed last year now limits your ability to change your mind.
The recharacterization strategy
When you convert a traditional IRA to a Roth IRA, you have to pay tax on all the contributions you're converting because you're changing tax-deferred money into an after-tax contribution. This can create a situation where you get over-taxed if the investment loses value later in the year.
For example, suppose that in early 2017 you converted $100,000 from a traditional IRA into a Roth IRA. You'd owe income tax on the $100,000 you converted. Now, suppose that later in the year your Roth investment declines in value, to $80,000. That means that you still have to pay tax on an additional $20,000 of income that is now gone. Ouch!
A process to undo Roth conversions called "recharacterization" had allowed you to move the Roth IRA contributions back into a traditional IRA. Your conversion tax bill would just go away and you wouldn't have to pay tax on money you no longer have.
Here's the bad news: the TCJA eliminates the ability to use recharacterization on Roth conversions made after 2017. For conversions made in 2017, you can still recharacterize funds converted into a Roth IRA all the way up to the 2017 extended filing date of Oct. 15, 2018, if you get a filing extension.
Because the TCJA tax bill now removes the ability to undo Roth conversions, you have to change your strategy. Here are some ideas:
The tax-free withdrawal benefit of Roth IRAs can be appealing. Just make sure you take a planned approach to your conversion strategy in light of the recent law changes.
As always, feel free to pass this Tip along to friends, and reach out if you need help with your personal tax and finance situation.
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