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September 30th

Last year the biggest trend in retirement fund management was to convert existing, traditional IRAs to Roth IRAs. Everyone’s tax attorneys and financial advisors begged their clients to move their funds over, claiming such a move would save a significant margin at tax time. Now, however, all the experts are advertising that it is time to move money back.

Originally, the reason behind moving funds to a Roth IRA was to save tax money. When the experts saw the potential for tax increases down the road, a Roth seemed like the logical solution. With a Roth, investors are able to lock down the current tax rate and avoid paying any future tax hikes. In addition, with a Roth IRA, investors are not required to begin withdrawals at the age of 70 ½, as they are with a traditional IRA, and any leftover funds are passed, tax-free, to heirs.

The Problem with a Roth IRA

However, the chief problem with this plan, and its fixed tax rate, is that investors could end up paying taxes on money they no longer hold. Even if the money depreciates in value, investors will still be paying the tax rate fixed for the total amount originally deposited. For example, if an original deposit of $100,000 lost half its value, the investor would not be paying a tax rate based on this new amount, but rather on the original $100,000. In addition, taxpayers could be forced to pay a higher rate than is offered to new investors if the tax rate decreases after the Roth tax rate is fixed.

As a result, many tax lawyers and financial advisors are now telling their clients to move money back into a traditional IRA. For those who converted last year at the peak of the craze, money may be converted back, or “recharacterized,” until October 17. In order to get money back, taxpayers should file an amended return with the IRS in order to “recharacterize” the invested money.


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