Re-converting a traditional IRA into a Roth IRA
To convert or not to convert?
That’s the question I’m facing now. Actually, I’m facing the question of whether to convert from a traditional IRA to a Roth for a second time. I converted the first time in February 2008. It was a rollover IRA from an old employer’s retirement plan, and I finally got around to turning it into a Roth. And then, along with the rest of the market, the account balance dropped by almost half. If I had kept it as a Roth, I would have had to pay income taxes on the high, February balance. So rather than take an unnecessary tax hit, I recharacterized it back into a traditional IRA.
Since then, and because of an extreme aversion to paperwork, I haven’t converted it back into a Roth. And now, of course, the market is up 30% from its low. I feel stupid for not converting it into a Roth again in March, when I would have paid the minimum in income taxes. But since that time has come and gone, should I wait? Or bite the bullet and convert now?
To answer this question, I turned to the fundamental source of my anxiety about re-converting. And that was: What if I’m wrong again and the market drops?
As I think the question through, holding out just in case the market retreats to new lows is a backhanded way of attempting to market time. If I really thought that the market was going to drop, I would move my IRA investments into a conservative bond fund or money market fund. I won’t do that, because I know that it’s just as likely, if not more likely, that the market will rise. So, the best time to convert from a traditional IRA to a Roth IRA is always going to be now, if I make the decision based solely on the direction of the market.
And what’s the worst that could happen? Well, I guess it’s that my account is worth less at the end of the year than it is now, in which case I simply recharacterize it all over again. I hate paperwork. But is a couple hours on the phone and in the post office worth several thousand dollars to me? Um, yes.
If you’re facing the same question I am, there are other things to consider. For example, your income tax bracket might change from year to year because you received a large bonus that didn’t come this year or vice versa. If you already have a lot of money in a Roth IRA but little in a traditional IRA or 401k, you might simply want to keep your tax-advantaged accounts diversified (that is, you might not want to commit fully to the idea that your taxes will be higher when you retire, which is what pre-paying taxes with a Roth does). But in my case, being unhappy in my market timing ability was no reason to delay.
A great source on IRA conversion and recharacterization rules is Fairmark.com. You can find their recharacterization literature here if you’re considering any of the same moves I am.
— Joe Light
