Reconversion

Reconversion is a method used by individuals to minimize the tax burden of converting an IRA by re-characterizing Roth IRA-converted amounts back to a Traditional IRA and then converting these assets back to a Roth IRA again. A reconversion can help the taxpayer save money on potential costs of converting an account by setting the amount he or she is taxed on at the reconversion value, not the original account value. Reconversions can be helpful, for example, if the value of an account falls and an investor wishes to convert it and pay taxes only the recalculated value.

Reconversion of an IRA account can only occur at specific times during the year. Investors who want to reconvert to a Roth IRA must wait until the beginning of the new tax year following the tax year they recharacterized or a minimum of 30 days after the recharacterization is completed, whichever is later.

For example, if you recharacterized a conversion contribution on December 15, 209, you would not be able to reconvert until January 15, 2010. If you reconvert prior to these limits, the reconversion will be deemed a failed conversion by the IRS, and if not corrected, may result in an excess contribution to the Roth IRA. Failed conversions will simply be treated as distribution from a traditional IRA or contributions from a Roth IRA. And because contributions to Roth IRAs have a pretty minimal limit, the investor is then at risk for created an IRA excess contribution, which could trigger a hefty 10 percent early distribution penalty, along with regular income tax. Investors should also be aware that the IRS released regulations in 1999 placing limits on reconversions.

An example of what a reconversion could look like would be if Sally decided to convert her traditional IRA into a Roth IRA. Because her traditional IRA had not been serving her well for tax-deduction purposes or growing as it should, Sally made the decision to switch her account. At the time of the conversion, her traditional IRA was valued at $200,000, but with the conversion, the investment value reduced to $100,000. With such a large disparity in value, if she kept the account as it was, she would be paying taxes on the larger value. To avoid paying unnecessary taxes, Sally then decided to recharacterize the conversion and thus, be taxed on the lower value.