Roth IRA may not be best decision for fast cash in retirement
Why to convert back
Many people looking for fast cash converted their IRAs into Roth IRAs. The move may have been a quick one and now some consumers are rethinking the decision. The value of a Roth IRA can be considerably lower than its former value due to the conversion and the taxes that can eat away at any savings. The reason for the high taxation is because consumers have to pay taxes on the full value of the amount converted. This is because contributions to a traditional IRA are on a tax-deductible basis, whereas Roth IRAs are made on an after-tax basis.
There are three reasons why consumers choose to reverse the conversion:
- The value of the Roth IRA is substantially lower due to the change
- The consumer wasn’t eligible for conversion, but did it anyway
- The consumer needs the money spent on taxes
The decision to converting back to a traditional IRA
It is possible to convert back to a traditional IRA, but consumers are warned to do it quickly. The first step is to make sure undoing the decision is the right one. Consumers who lost money due to the recession should make the change back if the losses were significant. A loss of a few hundred dollars most likely isn’t enough to turn back, but a few tens of thousands can warrant the change. For example, if an account holder converted a traditional IRA worth $100,000 with conversion cost at $20,000, then filing an amended return would add up to $5,000 for someone in the 25% tax bracket. That is a large enough loss to warrant a return to the old fund.
Talking to the IRA custodian
Talking to the IRA custodian is very important when it comes to converting back to a traditional IRA. Normally the custodian will be either a bank or a brokerage house. Customer service should be able to guide the account holder through the process and contribute the money back to the IRA. To make the conversion, consumers need:
- The account number
- Date of the first conversion
- Amount of investment gains
When converting back to a traditional IRA, there isn’t a lot of fast cash to be had. The transaction is beneficial for the future, but not necessarily an immediate gain.
Amended tax returns
A conversion of the IRA includes filing Form 8606 with an amended tax return. The custodian of the account should provide two Form 5498s and each will prove the amount of the conversion and the amount of re-characterization. The amended return must be filed by October 15th of the tax year in which the conversion occurs. The amended return, or 1040X, will also show how much a consumer paid as a result of the initial conversion and how much interest the IRS owes them on taxes already paid.
Overall, the IRA is a safe savings tool that has helped millions of Americans to amass wealth tax-free. The conversion possibility was introduced and many people jumped to change their IRA to a Roth IRA before thinking the decision out. It may benefit some consumers, but it isn’t always a way to fast cash. That’s why so many people are opting to revert back to the tradition savings vehicle.