30 Mar Tax Act Tip: Change Your Roth Conversion Thinking
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.
Change your strategy
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.