Roth Conversions are a Great and Flexible Tax Planning Tool

This year may be the last chance to take advantage of the relatively low tax by executing a Roth conversion.

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You may be pondering what to do (if anything) before the end of the year and the possible end of the Bush-era tax cuts. Don’t forget the most flexible tool in your list of tax planning strategies – the Roth conversion. A Roth conversion allows you to avoid paying the potentially higher 2013-and-beyond tax rates on traditional IRA funds. You simply convert all or any part of those accounts to Roth IRAs and pay taxes on those funds at 2012 rates.

Nearly everyone is a good candidate for a Roth conversion, as long as you expect to remain in the same (or higher) tax bracket and can pay the taxes on the conversion from funds outside the Roth. Anyone who believes they will be in a lower tax bracket in 2013 and beyond should wait to execute a Roth conversion.

What makes the Roth conversion such a great planning tool is the ability to reverse, or “recharacterize” (in tax speak), the transaction as late as October 15th of the year following the initial conversion. You can recharacterize all or a portion of the conversion until this deadline. You might recharacterize if you discover that your tax situation is actually better in 2013 or if the assets in the Roth you converted performed poorly. Congress could pass a major tax reform bill early next year that would provide lower tax rates across the board (don’t laugh, it could happen). No matter what the reason, you can press the undo button and there would be no tax implications.

Massive federal deficits make the possibility that tax rates will continue rising for the foreseeable future very real. This year may be the last chance to take advantage of the relatively low tax by executing a Roth conversion. But the time to act is now—before the end of the year.

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