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Dear Dr. Don,
I converted my traditional individual
retirement account to a Roth in March 2008 and it is entirely invested in one
mutual fund. Since the conversion, the value of my Roth has decreased from $17,635
in March to $10,985 in November.
I realize that I could undo the conversion, but I'm worried
that the market could rebound before I can reconvert back to a Roth 12 months
later. I'm 27 years old and can pay the taxes on the conversion without tapping
my IRA. What would you recommend given my situation?
-- Daniel Do-over 
Dear Daniel,
A key assumption is that this conversion
was done for the 2008 tax year. Your 2007 tax return should help clarify if this
was the case. Review your tax return if you're unsure.
If you
did the conversion for the "2007" tax year, you're past the point where you can
recharacterize the conversion. Otherwise, read on. Taxes on
the Roth IRA conversion are based on the value at the time it was converted. Assuming
you're in the 25 percent marginal federal income tax bracket, if you don't recharacterize
the Roth IRA, you'll owe about $4,400 in tax. Recharacterize the conversion as
a traditional IRA and you won't owe the taxes. You're right
that by doing the recharacterization, you'll have to wait to reconvert to the
Roth IRA. IRS Publication 590, "Individual
Retirement Arrangements," provides an example that matches your situation
and explains the horizon for reconverting to a Roth IRA: If
you convert an amount from a traditional IRA to a Roth IRA and then transfer that
amount back to a traditional IRA in a recharacterization in the same year, you
may not reconvert that amount from the traditional IRA to a Roth IRA before:
- The beginning of the year following the year in which
the amount was converted to a Roth IRA.
- Or, if later, the end of the 30-day
period beginning on the day on which you transfer the amount from the Roth IRA
back to a traditional IRA in a recharacterization.
I
don't understand why you'd be willing to pay $4,400 for the privilege of keeping
the money in a Roth IRA. You've already taken roughly a 40 percent hit in the
fund -- and that ignores the tax impact. Why pile on another 25 percent? A
recharacterization would leave you worse off only if the fund's value was above
the $17,635 value of the first conversion. I'm no market prognosticator, but my
guess is that you've got some time on your hands before this account sees that
valuation. You can reinvest the traditional IRA monies to capture
any rebound in the market. Sure, you'll owe federal income taxes when you reconvert.
But by the time you are eligible to reconvert, do you really expect the account
will be worth more than the $17,635 it was worth this spring? By
the way, you should run all of this by your tax professional because there are
details about your financial situation not presented here that could make a difference
in your decision. These include the expected tax bracket you'll be in when you
have the opportunity to reconvert, as compared to your current marginal federal
income tax bracket. | 
