An Early Roth IRA Conversion Tip

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It’s best to take action early in the tax year if you want to roll funds into a Roth IRA. That’s because an early move into a Roth typically gives you the option to re-convert your funds through October 15th of the following tax year. The IRS calls this process recharacterization.

Example: Sam converts $50,000 from a Traditional IRA to a Roth in January. By October, the Roth is worth only $40,000 because Sam’s investments lost value. If Sam does nothing he will still pay taxes on $50,000 converted from his Traditional IRA in January. Instead Sam can recharacterize some or all of the funds back into a Traditional IRA and pay no taxes on the conversion.

Here are some things to consider with an early rollover to a Roth IRA.

  • Full year of earnings growth. After your conversion, you will have a full year to build after-tax earnings (or accumulate losses) in your new Roth, giving you time to see if a recharacterization makes sense.
  • You have a full year to plan for the tax. Remember, you will want to pay the tax on rollovers with after-tax funds. This allows you to maximize the amount converted.
  • Separate the account. Keep the funds you convert in a separate account from other Roth investments. This will keep the account clean should you need to undo your conversion.

Each person’s situation is unique. Carefully review your options prior to taking action.