How Roth IRA Conversion Recharacterization Works
Say your Deductible IRA owns $300,000 stock mutual funds at the beginning of the year. You converted and owed $120,000 in taxes. A year later, due to the economy, your stock funds are worth only $180,000. You still owe $120,000 to the IRS — leaving you with a paltry $60,000.
So you recharacterize. This turns your account back into a Deductible IRA. It's worth $180,000 (due to the market's decline). You convert all over again — and this time, you owe taxes of just $72,000 (assuming the same tax bracket as in the above calculation). Recharacterizing has just saved you $48,000!
While it's always possible that the stock market might decline 38% in a single year (like it did in 2008), it's unlikely that you will place your entire Roth IRA into stocks. It's more likely that you will diversify among a variety of asset classes, with some performing better than others.
What if you just want to recharacterize some of your converted money, but not all? Please keep reading our next blog post.