Tips to Maximize Benefits of an IRA Conversion

There are some strategies that will increase the benefits of an IRA conversion or help you turn a conversion mistake into a benefit.

Convert in stages. It can be expensive to convert all of a large IRA in one year. You might not have enough cash to pay the taxes, or the conversion could push you into a higher tax bracket. Instead, convert a portion of your IRAs each year. Convert just enough to keep you from rising to the next tax bracket or triggering stealth taxes.

Convert to multiple IRAs. Ideally, a diversified traditional IRA shouldn’t be converted into one diversified Roth IRA. Instead, each different investment or asset class in the old IRA should be put into its own Roth IRA.

You see, the taxes on a conversion are computed on the value of the assets on the date of the conversion. If the converted IRA subsequently declines in value, you still pay taxes on the higher converted value. When you put each asset in a separate Roth IRA, you have the option to recharacterize (reverse the conversion of) any asset that declined in value and keep the others in their Roth IRAs. You won’t be paying taxes on a value that no longer exists.

Monitor converted IRAs. You have the right to reverse a conversion by Oct. 15 of the following tax year. Follow your converted IRA or IRAs and recharacterize those that have declined substantially as you near the recharacterization deadline.

Reconvert. You have another shot at a conversion if you converted assets and then recharacterized them. The reconversion can’t occur in the same year as a recharacterization. Also, at least 30 days must pass between the recharacterization and reconversion.

Example. A converted Roth IRA is recharacterized to a traditional IRA on Dec. 15, 2015. The owner can’t reconvert until Jan. 15, 2016. He has to wait until the later of the next calendar year and 30 days before reconverting.

Example. A converted Roth IRA is recharacterized to a traditional IRA on July 1, 2015. The IRA can be reconverted on Jan. 1, 2016, because that is the later of 30 days and the next calendar year after the recharacterization.

The backdoor conversion. Achieve tax diversification without the expense of converting an existing traditional IRA. Make a nondeductible contribution to a traditional IRA. Shortly afterwards, convert it to a Roth IRA. There should be little or no tax on the conversion. You can do this every year.

RW February 2015.