Roth Conversion Strategy to Minimize Taxes

Posted by Madison on April 27, 2010

Since the number of Roth IRA conversions per year is unlimited, and we have the ability to unconvert the Roth IRA conversions, there’s a fantastic strategy to Roth IRA conversions to minimize your taxes!

We previously explored roth conversion strategies like increasing your basis to avoid taxes, but if you’re ready to convert the taxable portion of your traditional IRA, this one might be for you!

Roth IRA Conversion Strategy

Here’s the plan to execute the Roth IRA conversion strategy:

Create multiple traditional IRAs. For example, if you have a $100,000 traditional IRA to convert, separate it into 4 $25,000 traditional IRAs.

Convert each IRA. For each account, make a traditional IRA conversion to a Roth IRA. You’ll want to keep each new Roth IRA separate.

Invest differently. In your new Roth IRAs, you’ll want to take a separate investment approach. Separating by each asset class would probably make the most sense and gives the most flexibility.

Monitor Returns. Since each Roth IRA holds a different asset class, the returns will vary. If the value goes up, leave it alone.

Recharacterize. Select the accounts where the value went down, which could be all, some, or none, of the new Roth IRAs. Reverse the conversions with a recharacterization by the tax deadline on April 15 (or by October 15 with an extension), for Roth IRA conversions.

Tax Savings. With this strategy you’ll avoid paying taxes on money you lost, without having to recharacterize the entire conversion, allowing you to keep the conversions on the winners!

Tips and Tricks

Reconvert. You can later reconvert the money that you recharacterized, but there is a waiting period of at least 30 days and at least until the next year. You’ll be able to reconvert at a lower value, which means lower taxes.

Rebalance and Consolidate. After you’re done converting, you can put the Roth IRAs back together for a more simplified record keeping.

Keep Good Records. The paperwork on this one could get very complicated if you take it to the extreme. Be sure to keep good records so you don’t make tax time next year a real headache!

Communicate Clearly. If you have multiple accounts, you’ll need to work closely with your broker to make sure the correct conversions and recharacterizations take place. I make Roth IRA conversions and recharacterizations at Vanguard.

More Helpful Roth IRA information:





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Comments to Roth Conversion Strategy to Minimize Taxes

  1. Thanks for the post. The Roth IRA conversion strategy is a good one. There are still too many people out there who don’t use the Roth IRA. If you have a 401(k) through work, that money is tax-deferred. The Roth is really the best compliment to the 401(k) if you can put more money in to retirement savings.

    Unfortunately, I believe that the reason more people don’t have Roths are that they don’t want to pay taxes now – and want the tax credit for savings they are able to put into an IRA. We live in a society that lives for “right now” and Roth isn’t a “right now” type of account.

    Please let me know if I can help with a Roth IRA. Roths are discussed in my upcoming book. “Help! My 401(k) Has Fallen – And Must Get Up!”

    Dean Voelker

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