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27 June 2017

Now’s the Time to Fix Rollover Mistakes

Now’s the Time to Fix Rollover Mistakes

If you filed an extension on last year’s income tax return and haven’t finalized yet, you have a unique opportunity to undo some of the decisions you made when it comes to your retirement savings. You can no longer make contributions or fulfill your required minimum distributions (if you’re 70½ or older), but you can make other changes.

One such change is the ability to withdraw excess contributions. The standard limit for contributing to both a traditional and Roth IRA is $5,500 ($6,500 if you’re age 50 or older). Those who exceed this limit, make a regular contribution to a traditional IRA at age 70½ or older, or make an improper rollover contribution to an IRA are taxed 6% per year on that amount. However, this tax can be avoided if you withdraw the excess amounts before the extended deadline (if you filed an extension).

Another decision you can make is whether to undo a rollover. Converting funds from a traditional IRA to a Roth IRA (called a rollover) is a popular strategy that allows you to pay tax on the conversion instead of when you withdraw the money (if you withdraw after five years and at age 59½ or older).

But the tax strategy isn’t advantageous in all cases.

If, by the extended filing period, you find that the converted funds have lost value (due to stock market fluctuations, for instance), you may want to recharacterize the rollover or, in other words, undo it and try it again another time. Take a look at this example based on a Financial Planning magazine article:

“Let’s say Joe Client converted a $200,000 traditional IRA to a Roth IRA…only to see a 20% loss [early the next year]. Joe may not want to pay tax on a $200,000 conversion in order to have a $160,000 Roth IRA. In that case, Joe can recharacterize the entire transaction, bringing the money back into a traditional IRA and avoiding any income tax on the conversion. Thirty days later, Joe can reconvert, perhaps paying tax on $160,000 of income rather than on $200,000.”

 

In similar circumstances, you may consider recharacterizing all or just some of the rollover. And, yes, you can reconvert after the reversal but you need to wait at least 30 days before doing so.

The decision to make changes to the retirement contributions you already made can be a tricky one. But it’s good to know you have options. For specific questions about taking the best tax advantage of your retirement savings, feel free to contact us.

Image Copyright: aruba2000 / 123RF Stock Photo
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