His explanation: "If the market goes down, we recharacterize the whole thing and call it an exercise in paperwork management. Market goes up, you turn the taxable gains that you would have had in the traditional IRA (had you done nothing) into tax-free money with all the tax advantages of a Roth. Market is flat, we have time to rethink our strategy. Flexibility all around."
A third strategy, the "Matrix Roth," combines vertical and horizontal strategies. Warning: It's complicated.
Whether you want to adopt such strategies depends on "how sophisticated, how technical, you want to be," says Jennings. "This is a kind of scenario you definitely want to walk through with your financial adviser. Especially for higher net worth individuals, you'd want to include an estate planner and an accountant as well. This is something that should be considered on a case-by-case basis."
Melissa Labant, a technical manager on the tax staff of the American Institute of Certified Public Accountants in Washington, D.C., agrees that it's important to consult with a tax adviser before taking steps to convert a Roth, especially when using strategies such as those recommended by LaBrecque.
"Converting a Roth may put you in a higher tax bracket, especially if you're going to have a lot of income in a certain year, so you might not want to convert your entire IRA, but a portion of it so you stay in a lower tax bracket," she says. She expects that more taxpayers than ever before will want tax projections earlier in the year from their CPAs, "because it's important in situations like this, when you might want to convert an IRA."
Conversion may also trigger the alternative minimum tax, which is an additional tax that generally higher-income taxpayers may have to pay, so you should be especially careful in your plans and consult with a CPA, Labant adds. It's always better to talk to your tax adviser before taking any actions that could result in problems later, she says.
Jennings cautions that recharacterization is not a permanent hedge against your Roth IRA losing value. "If you're going to segregate your IRA funds into separate accounts, that's fine, but you have to keep in mind that with recharacterization you only have a limited amount of time under which you can recharacterize."
Once you convert to a Roth IRA in 2010, you have until the due date of your 2010 return (or Oct. 15, 2011, including extensions) to recharacterize; after that, you lose the opportunity. To recharacterize, you must file Form 8606 with your amended tax return, which is Form 1040X.
If you do choose to recharacterize, you can later reconvert that traditional IRA to a Roth IRA, but you have to wait until 30 days after the recharacterization or one year after the initial conversion, whichever is later, according to IRS Publication 590. If you don't recharacterize, you can combine those multiple Roth accounts once the deadline for recharacterization has passed, notes LaBrecque, which can save you recordkeeping hassles as well as IRA custodial fees.
Does a Roth conversion make sense for you? Bankrate's Roth conversion calculator can help you decide.
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