Roth IRA conversions offer a unique "look-back" opportunity. You can recharacterize (reverse) all or part of a Roth IRA conversion up to October 15 of the year after the conversion. If your IRA has lost value, this tactic allows you to avoid paying income tax on assets that no longer exist.
For example, suppose Bob Harris converted a $100,000 traditional IRA to a Roth IRA in April 2008. By March 2009, his Roth IRA had dropped because of the stock market crash so it was worth only $50,000.
Bob, in a 28% tax bracket, would have had to pay $28,000 in tax (28% of $100,000) for a Roth IRA now worth only $50,000. Instead, Bob could have recharacterized back to a traditional IRA in 2009 (up to the October 15 deadline) and avoided paying any tax.
Even without a stock market crash, recharacterization might be a good idea. Suppose Bob Harris realizes that he can’t afford to pay $28,000 in tax but he can afford to pay $14,000. He could recharacterize one-half of his Roth IRA back to a traditional IRA and pay tax only on the half of the conversion that remains in place.
