| By Leon Labrecque
This option will help your clients undo their Roth IRA conversions.
FINANCIAL PLANNING
The Mulligan Shot
Most of us understand the basic oncept of converting an IRA into a Roth IRA; however, a
lot of us don’t know about the “undo”
option of a Roth conversion through
what is called a “recharacterization.”
This concept is very similar to a Mul-
ligan shot. One day, a French Canadian
named David Mulligan hit a poor shot in
his golf game, set down another ball and
hit it. His foursome dubbed the do-over
a “Mulligan.” Knowing that the Mulli-
gan option is available will help you help
your clients when they are converting
their IRAs.
Most people have heard about Roth
conversions and how useful they are. You
get to take money from an existing IRA
or a qualified plan, convert all or part of it
into a Roth IRA, pay the tax and create a
nice tax-free accumulation vehicle.
“Recharacterization” is reversing the Roth conversion. Why is this
important? Say your client wants to
convert an IRA worth $100,000. The
market goes down and now his account is worth only $80,000. He
can “recharacterize” the Roth back
to a regular IRA and not pay the
taxes (or get a refund if he paid the
taxes). What’s more, he can reconvert
the IRA to a Roth. In other words, he
gets a “do-over” or a Mulligan.
ize. If he converts in 2010, he has
until Oct. 15, 2011. If he recharacterizes and then reconverts, he pays
taxes on the conversion in the year
he converts. This means that if he
converted an IRA to a Roth in 2009,
recharacterized in 2010 and then
reconverted, he would pay the tax in
2010. Special rules will also allow
him to pay the tax in 2011 and 2012.
Also, once he recharacterizes a Roth,
he may not reconvert it for 30 days.
There is a loophole that allows him to
take more than one Mulligan. With Roth
conversions, he can have multiple “looks”
at a do-over. The rules on recharacterization are at the account level. This means
that your client can have multiple Roth
conversion accounts and can selectively
recharacterize those conversions. By
segregating Roth conversion IRAs, each
holding different investments, he may
selectively recharacterize.
Your client can
have multiple
Roth conversion
accounts and
can selectively
recharacterize
those conversions.
Mulligan rules
Just as in golf, there are rules governing the Mulligan option. Your client can
only recharacterize a Roth conversion
account once, and then only up to the
due date of his tax return, including
extensions (provided he filed a timely
return). This timeline is irrespective of
when he files his return.
Therefore, if he converted to a
Roth last year, for instance, he has
until Oct. 15, 2010, to recharacter-
plan. The general idea is to allow flexibil-
ity for recharacterizations, which creates
numerous Mulligan opportunities.
A case in point
Suppose your client has a $100,000
IRA consisting of $50,000 of AAPL
stock and $50,000 of F stock. Suppose,
also, that the AAPL stock decreases to
$35,000 and the F stock increases to
$60,000. If he converts both securities
into one Roth, he may only recharacterize the entire account, and his tax
savings would only be on $5,000 (the
original $100,000 conversion, less the
$95,000 recharacterization). But suppose he placed two Roth conversions
into separate accounts, maybe a day
apart, one holding the AAPL stock and
the other holding the F stock.
The AAPL Roth could be recharacterized, and the F Roth could be left
alone. He is then saving ordinary income
tax on $15,000. After 30 days, he could
reconvert the AAPL Roth. There are
multiple options under this segregation
Leon Labrecque is the managing partner
and founder of LJPR, LLC, an independent wealth-management firm in Troy,
Mich. LJPR reduces uncertainty for its
clients’ finances by providing creative
wealth-management solutions in investments, taxes, financial planning and estate
planning. Contact Labrecque at leon.
labrecque@ljpr.com.
