Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2018 • March 5, 2024 9:06 PM
OVERVIEW
Under new rules that took effect in 2010, you can convert a traditional IRA into a Roth IRA no matter what your income is. If the conversion turns out to have adverse tax consequences, you'll have plenty of time to reverse the whole transaction, but only for tax years prior to 2018.
Roth conversions are more popular than ever after the income limits for making one were removed in 2010. Inevitably, you may wish to undo a conversion, perhaps due to poor investment performance. For tax years before 2018, you had until October 15th of the year after making a conversion to reverse it and avoid the related tax liability. Beginning with the 2018 tax year, undoing Roth conversions are no longer permitted. Before we cover the details of reversing a conversion, let’s go over some background information.
Conversions are taxable transactions
Let’s say you convert a traditional IRA into a Roth in 2017. The transaction is treated as a distribution from the traditional IRA, followed by a contribution of the distributed amount to the new Roth account. If you only have one traditional IRA, the amount of the distribution to be taxed equals the account balance on the conversion date minus any nondeductible contributions.
- For example, say you have a traditional IRA worth $50,000 to which you made $5,000 in nondeductible contributions. The taxable distribution amount is $45,000. If you didn’t make any nondeductible contributions, the taxable distribution would be the entire account balance of $50,000.
If you own several traditional IRAs, you must aggregate (add together) all their balances and nondeductible contributions to determine the taxable distribution. Because the aggregation rule makes the taxable distribution the same no matter which account you convert, you can’t reduce the taxable distribution amount by converting an IRA with a larger proportion of nondeductible contributions.
You can reverse a conversion
If the investments in your new Roth IRA lose value after the conversion, you’ll have an adverse tax outcome, because the taxable distribution from the conversion will still be based on the value of the account on the conversion date. In other words, you’ll wind up owing taxes on money you no longer have.
- Going back to our example, let’s say the value of the Roth IRA drops from the initial $50,000 to $35,000. You’ll still have a $45,000 taxable distribution from the conversion, even though the Roth account is now worth only $35,000.
Fortunately, you can avoid this unfavorable outcome by reversing the Roth account back to traditional IRA status. The IRS calls this process recharacterizing the account. Once the recharacterization is complete, you’re right back where you started, tax-wise—though your IRA is now worth $35,000 instead of $50,000. To summarize: the conversion is reversed, the $45,000 taxable distribution disappears,(along with the related tax liability), and the account is again a traditional IRA worth $35,000.
Mind the deadline
To reverse a conversion by recharacterizing an account back to traditional IRA status you must submit the required form to your Roth IRA trustee or custodian by October 15 of the year after the conversion takes place. If October 15 falls on a weekend, the deadline is the following Monday.This flexibility makes the conversion idea that much more appealing.
If you’ve already filed your tax return for the year of the conversion but it isn’t yet October 15, you still have until that date to reverse the conversion (with extra days in years when October 15 falls on a weekend). To get back the tax you paid on the conversion you would then need to file an amended tax return (using Form 1040-X) by the due date for amended returns. (Usually you have three years after the date you filed the original return, but you shouldn’t wait that long to seek a refund from reversing a Roth conversion.)
What to show on your tax return
When you make a Roth conversion, your IRA trustee or custodian reports the resulting distribution to you on Form 1099-R, which you should receive by February 1 of the year after the conversion. If you choose to reverse the conversion TurboTax can lead you through the necessary tax reporting.
You can reconvert later
While poor performance by Roth investments may prompt you to reverse a conversion, you might want to reconvert that same account into a Roth IRA later on. Reconverting the account when it has a lower balance will mean a lower taxable distribution and a reduced tax hit. However, Congress has placed timing restrictions on reconversions. For an account that was originally converted to a Roth in 2016 and then reversed to a traditional IRA in 2017, you have to wait until 30 days after the reversal date to reconvert. If you reverse a 2017 conversion in 2017 you can’t reconvert the account before January 1, 2018.
The tax law rarely gives you this much flexibility so the Roth conversion idea deserves some serious consideration. For instance, if youdecide to convert in early 2017, you would have nearly two years to evaluate the results of the conversion to make sure it was the right move for you. If not, you can reverse the deal under the rules explained earlier.
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FAQs
For tax years before 2018, you had until October 15th of the year after making a conversion to reverse it and avoid the related tax liability. Beginning with the 2018 tax year, undoing Roth conversions are no longer permitted.
What is the loophole for Roth IRA conversion? ›
A backdoor Roth IRA is a conversion that allows high earners to open a Roth IRA despite IRS-imposed income limits. Basically, you put money you've already paid taxes on in a traditional IRA, then convert your contributed money into a Roth IRA, and you're done.
Will backdoor Roth conversions be eliminated? ›
While it doesn't look like they'll be eliminated in 2024, the future of the Backdoor Roth IRA remains a target of proposed legislation. Some legislative efforts have already been taken to limit Roth IRAs or to change tax brackets and RMDs in the future.
What is the downside of converting IRA to Roth? ›
Disadvantages of Converting to a Roth IRA
Higher taxable income that year could have one or more of these negative effects: A higher tax bracket, A higher portion of Social Security benefits subject to tax, Higher Medicare premiums, and.
Can Roth conversions be withdrawn? ›
The Internal Revenue Service (IRS) requires a waiting period of 5 years before withdrawing balances converted from a traditional IRA to a Roth IRA, or you may pay a 10% early withdrawal penalty on the conversion amount in addition to the income taxes you pay in the tax year of your conversion.
How long does it take to recharacterize a Roth conversion? ›
Roth IRA Recharacterization Rules from the IRS
A Roth IRA contribution can be partially or wholly recharacterized as a traditional IRA contribution, as long as you recharacterize the contribution by October 15 of the year following the year in which you need to make the adjustment.
What is the 5 year rule for Roth conversion? ›
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
At what age can you no longer do a Roth conversion? ›
However, there are no limits on conversions. A taxpayer with a pre-tax IRA can convert any amount of funds in a year to a Roth IRA. Roth IRAs also are exempt from required minimum distributions (RMDs). These mandatory withdrawals from retirement accounts begin at age 72 and can create a tax burden on affluent retirees.
At what age does a Roth IRA not make sense? ›
Even when you're close to retirement or already in retirement, opening this special retirement savings vehicle can still make sense under some circ*mstances. There is no age limit to open a Roth IRA, but there are income and contribution limits that investors should be aware of before funding one.
Is the backdoor Roth going away in 2024? ›
Right now, the mega backdoor Roth is not going away as long as your employer plan allows it. That's good news! But it's not permanent news – there could be legislation on the way that eliminates the option to make after-tax contributions.
You can't undo a Roth conversion.
You may find dividing your savings between a Roth and a traditional IRA or a Roth IRA and a traditional 401(k) is the optimal solution for you.
What is the difference between a backdoor Roth conversion and a regular Roth conversion? ›
A back-door Roth conversion differs from a regular Roth conversion in that the funds being moved are after-tax IRA funds to an after-tax Roth IRA account. An individual may have after-tax funds in an IRA because they were/are unable to take a tax deduction for the contribution due to income limitations.
Can you reverse a Roth conversion? ›
If I convert to a Roth, can I reverse the conversion if the taxes are more than I expected? No, Roth conversions cannot be reversed. Tax planning is an important part of the conversion process.
When not to do Roth conversion? ›
In its simplest form, the decision in favor or against a Roth Conversion can be boiled down to one question: Are you paying a lower tax rate now than you will be in retirement? If yes, there's a good chance that conversions make sense. If not, a conversion likely does not make sense.
How do you not lose money in a Roth IRA conversion? ›
Bottom line. If you want to do a Roth IRA conversion without losing money to income taxes, you should first try to do it by rolling your existing IRA accounts into your employer 401(k) plan, then converting non-deductible IRA contributions going forward.
Can you reverse a 401k Roth conversion? ›
Note that this only applies to taxable money that was converted; it does not apply to any balances that were not taxable when converted such as conversions of after-tax contributions to a traditional IRA. Another important fact to understand—there's no way to undo a Roth conversion.
What is the 5 year rule for Roth conversions? ›
The Roth IRA five-year rule says you cannot withdraw earnings tax-free until it's been at least five years since you first contributed to a Roth IRA account. This five-year rule applies to everyone who contributes to a Roth IRA, whether they're 59 ½ or 105 years old.
Do Roth conversions have a penalty? ›
Note also that while a conversion prior to age 59½ will not trigger a 10% early withdrawal penalty on the taxable amount converted, a subsequent distribution from the Roth IRA within the 5-year period that begins on January 1 of the year of the conversion may trigger a "recapture" of that penalty.
Can you offset Roth conversion with losses? ›
Under current tax rules, business owners are forced to carry forward these losses on tax returns. * Business owners may be able to use a loss to offset income generated from a Roth conversion, which may provide efficient tax planning today while creating a source of tax-free retirement income in the future.
