Simply put, a conversion is the movement of retirement funds from a pre-tax account environment to a post-tax account environment. A pre-tax environment refers to retirement plans where the taxes are not paid prior to contributions being deposited into the account, with funds taxed at the time of withdrawal. This is in comparison to a post-tax environment, as taxes have been paid on contributions and will not be taxed when withdrawn. A traditional IRA
, SIMPLE IRA
, and a SEP IRA
are all retirement plans with pre-tax environments with the option of converting funds to the post-tax environment of a Roth IRA
These environments are also described as “tax-free” versus “tax-deferred.” Remember, each plan type has the potential of penalties if funds are withdrawn outside of the established account rules
Keep in mind that a conversion is a taxable event and must be reported on Federal Income taxes. The converted amount is added to your ordinary gross income for the year and taxed accordingly. Conversions must be completed by December 31st, and reported to the IRS for the calendar year in which the conversion was completed. The associated taxes are due for payment by the filing deadline for reporting year in which the conversion occurs in the Roth account. Initiating a conversion earlier in the year gives you more time to plan for the taxes due.
Since non-traditional assets such as real estate may be converted, it is vital to anticipate the need for a fair market valuation of the asset prior to conversion. Exploring if a Roth conversion is the right course for your retirement goals earlier in the year – instead of closer to the year-end deadline – will give you more time to complete any valuation needs.
, “A recharacterization allows you to “undo” or “reverse” a rollover or conversion to a Roth IRA. You generally tell the trustee or custodian holding your Roth IRA to transfer the amount to a traditional IRA. If you do this by the due date for your tax return (including extensions), you can treat the contribution as made to the traditional IRA for that year (effectively ignoring the Roth IRA contribution).”
It’s important to note, it may be possible to recharacterize a rollover or conversion by October 15th of the following year, regardless of whether you requested an extension to file your tax return. Exploring this option in July may allow a greater opportunity to review with your tax or financial advisor – without the added weight of a fast approaching October deadline.
As with all tax, financial, and legal concerns, consulting with your trusted advisors and other qualified professionals is in your best interest to determine if these actions are in the best interest for your retirement goals. Initiating these vital discussions earlier in the year will give you more time to explore possible options in depth and make any necessary preparations.