October 15, 2012 could mark an important date for many of your clients. For clients that made Roth IRA conversions in 2011, October 15, 2012 marks the last day on which they can change their minds and get back any tax paid as a result of the conversion. The more formal name for this transaction, of course, is a Roth recharacterization, but for most clients, it’s simply the way their financial or tax advisor promised them they could undo their Roth IRA conversion and resulting tax consequences.
The Roth recharacterization deadline is nothing new, but like a modern remake of a classic film, this latest version has the same overall message, but with a slightly different twist. Helping clients and prospects to understand the subtle wrinkles that make this year’s Roth recharacterization deadline unique can help you solidify yourself as an expert who maintains a solid handle on the ever-changing economy, stock market and tax laws.
What’s Different About Roth Recharacterizations Now?
So what’s different about this year’s recharacterization deadline? This year, for the first time since the floodgates opened on Roth conversions in 2010 (when the Roth conversion restrictions were permanently repealed), the majority of Roth IRAs being evaluated for recharacterization should be up in value.
Since the start of 2011 through the first two-thirds of 2012 (the end of August), the S&P 500 index is up roughly 12%. In contrast the S&P 500 was down roughly 6.5% from January 2010 through the end of August 2011 (and was still down about 2.5% on the October 15,2011 recharacterization deadline for 2010 conversions). Since, for the most part, the market has cooperated since 2011, fewer recharacterizations will be made as a result of lost value. That’s good news for clients who see the potential long-term benefits of the Roth IRA and good news for advisors, who may be able to cut-down on paperwork as opposed to this time a year ago.
Another (potentially) unique aspect of this year’s Roth recharacterization deadline is that the favorable “low” federal income tax rates clients have enjoyed for 10 years may soon be coming to an end. As it stands now, income tax rates are set to increase in 2013, with the top rate going from the current 35% up to 39.6%. Add in the 3.8% surtax on net investment income also slated to kick in at the start of 2013 and high-income clients could pay as much as 43.4% in federal income tax alone.
Recharacterization and Reconversion
A recharacterization could make sense for clients for any number of reasons, but they should still be mindful such a transaction might ultimately lead to a greater tax burden in the future. If a recharacterization of a 2011 Roth conversion makes sense now, but the Roth IRA is still desired long-term, clients can still lock in the current low rates.
Any 2011 Roth conversion recharacterized by the October 15, 2012 deadline can later be reconverted back to a Roth in 2012, guaranteeing that the tax on the conversion will result in no more than a 35% federal income tax hit. Don’t reconvert back right away though! A 2011 conversion recharacterized in 2012 can only be reconverted back to a Roth IRA after 30 days have passed since the recharacterization.
Pages: | Next →