For those of you who took advantage of the one-time opportunity in 2010 to convert IRA funds to Roth IRA accounts, spreading the tax over the following two years (2011 and 2012), you are faced with a decision-point: if you have reason to recharacterize the conversion, you have to do this by October 18, 2011.
Here’s a ferinstance: If you converted $10,000 from your IRA account on December 31, 2010 into your Roth IRA and invested it in the S&P 500, that $10,000 converted is now worth approximately $8,997 (using a recent price).
If you are in the 25% bracket, you will owe $2,500 on the conversion, which equates to 27.79% in taxes on the conversion. If your chosen investments did worse than the S&P 500 (and you know some of them probably did), your effective tax will be even higher.
Now, chances are that your investment may increase in value before you actually pay the tax on your 2011 and 2012 returns, but then again maybe it won’t. Why pay the extra tax (or rather, the tax on the extra amount) if you don’t have to?
You can recharacterize the amount in your Roth IRA that corresponds to this conversion back into your traditional IRA – but you must do it before October 18. At that time, you’ll also want to file an amended tax return showing that the conversion “did not happen” for tax year 2010.
But, what if your investments gained value?
If you bought the S&P 500 about a year ago with that same $10,000, it’s likely worth about $10,335 today, so you might want to leave the conversion alone. Now your effective tax rate on the conversion (if you’re in the 25% bracket) is only about 24.19%. Granted, it’s not a dramatic increase, but still it probably is better than you originally thought when you started this process. And you’ve got two more years to pay all of the tax.