Converting an IRA to a Roth IRA means paying the deferred tax now but collecting tax-free income after five years and after you reach age 59 1/2. You may come out ahead by dividing your IRA into mini-IRAs before converting.
Say you have a $250,000 IRA: $150,000 in stocks and $100,000 in bonds. You could divide your IRA into two different IRAs, one for stocks and one for bonds. No tax will be due on this rearrangement. Then you’d convert both IRAs and pick up $250,000 in additional taxable income in 2002.
By mid-2003, suppose stocks are up but bonds are down in value. You could recharacterize (rescind) the bond IRA to cut your cost of converting to a Roth IRA. After 30 days, you can reconvert the bond IRA to a Roth IRA. If your bond IRA has fallen from $100,000 to $85,000, you’d pick up $15,000 less income and save yourself around $6,000 in taxes.
