Monday Deadline for Recharacterizing 2000 IRA

Retirement investors have until Monday to undo some of the decisions they made last year and save money in the process.

By law, people who converted their traditional individual retirement account to a Roth IRA in 2000, or who made contributions to a Roth, have until Oct. 15 to change their minds.

Using today’s lower stock prices, investors can save big bucks on their tax bills by reconsidering their IRAs, said Ed Slott, a CPA who specializes in IRA intricacies and publishes Ed Slott’s IRA Advisor.

Most people who transferred money from a traditional IRA into a Roth last year have less now than they did then, because of the stock market’s rout. To save money on taxes, they can undo or “recharacterize” last year’s transaction and, if they want, transfer back to the Roth anew for tax year 2001.

Say a taxpayer had a $60,000 IRA invested in the Vanguard Total Stock Market Index fund in 2000 and decided to move that money into a Roth IRA. In the 28% bracket, with a 7% state tax rate, the taxpayer would have owed as much as $21,000 in income taxes on that transfer.

But in the last year, that fund has lost 27.8% of its value, according to Morningstar Investments. It now is worth only $43,320. By undoing the 2000 conversion and converting the money back to a Roth for 2001, the tax bill can be lowered to $15,162. Thus, a $16,000 market loss could be partly offset by $7,000 in tax savings.

Note that with all of this transferring and recharacterizing, the taxpayer never actually gives up the Vanguard investment. It’s simply being recharacterized from one kind of account to another, and back again.

To recharacterize an IRA contribution, taxpayers who have already filed for an extension until Oct. 15 should file Form 8606 with their 2000 tax return. Those who have already sent in their returns can find an amended version using Form 1040X. Forms can be found at https://www.irs.gov; returns must be postmarked by midnight Monday.

There are other reasons to recharacterize 2000 IRA activities, Slott said. People who have lost their jobs after converting to a Roth may need the money they would otherwise owe in taxes on the conversion. Others may have made a mistake by contributing to a Roth when they were not eligible. (To qualify for a Roth IRA, taxpayers must have made less than $150,000 as a couple filing jointly or $95,000 as a single filer.)

Still others may have started with a Roth IRA last year, but not realized they were eligible for a deductible IRA, which can be a better deal.

Those who decide to take this second shot at last year’s history should move quickly and read all paperwork carefully. Slott said he expects there to be a rush on the banks and brokerages, and many people trying to slip in under that Oct. 15 wire. All those requests may beget delays or even mistakes.