How to Undo a Roth IRA Conversion and Save Money

Losing money in the stock market is never fun, but what’s worse is having to pay tax on the lost market value. In 2010, the IRS changed the rules to allow anyone, regardless of their income, to convert an old 401k or a Traditional IRA to a Roth IRA, as long as they pay the tax on the converted value. Many people in the “higher” income brackets have taken advantage of this window of opportunity to gain access to the coveted Roth IRA, which is not available to high income earners.

Even though investors have to pay tax on the converted value, they can side-step the mandatory Required Minimum Distribution rules, and enjoy many other advantages specific to the Roth IRA such as tax-free investment growth. Although the investors who converted to a Roth IRA were smart in doing so, unfortunately, they saw the value of their new Roth IRAs decline as the economy weakened. The even more unfortunate part is that they owed taxes on a much higher account value. If you were one of these investors, you may feel like you’re stuck having to pay tax on the originally converted amount, however, there is good news! What many people don’t realize is that the IRS allows investors to “undo” a Roth IRA conversion, by October 17, 2011, without penalty in what is known as a recharacterization.

Let’s take a closer look.

Assume that in 2010 you converted your Traditional IRA (worth $100,000) into a Roth IRA; you would have to recognize and pay tax on $100,000 in income for 2010. If you are in the 25 percent tax bracket, that means you would owe $25,000 in taxes. Let us assume further that given the recent market volatility, your account is now worth $80,000, though you still owe taxes on the original $100,000.

However, if you take advantage of the IRS allowed recharacterization and convert your Roth IRA back to a Traditional IRA, you can undo the original conversion and not owe any taxes. Worried that you won’t be able to reap the benefits of the Roth IRA in the future?  Don’t worry. After the later of a 30-day waiting period or January 1st of the year following your original conversion, you can always convert back to a Roth IRA.

How Much You’ll Save

Assuming the value stays at $80,000 when you decide to convert back to the Roth IRA, you would then owe $20,000 (25 percent of $80,000) instead of the original $25,000, for a nice savings of $5,000. If you have already filed and paid your 2010 taxes, you can file an amended return and claim a refund for the excess taxes you paid.

The conversion process is fairly simple, but you must remember to file by the deadline. To initiate a Roth IRA recharacterization, you must submit paperwork to your custodian (the brokerage that holds your accounts, i.e. Scottrade) of your intention by October 17, 2011 to undo a 2010 conversion. If you rolled over from a previous employer’s 401k into a Roth IRA, you can still recharacterize, but you must transfer the Roth IRA assets to a new or existing Traditional IRA, not back into the original 401k plan.

About the author

Ara Oghoorian, CFA, CFP®

Ara Oghoorian, CFA, CFP® is the founder and president of ACap Asset Management, Inc, a financial advisory specializing in working with medical professionals. Ara has over 20 years of experience in the financial services industry. Prior to starting ACap, Ara worked for a wealth management firm in the Washington, DC area providing investment management, tax preparation/planning, financial planning, complex risk-management strategies, and financial advice to ultra high net worth individuals and institutional clients.

Ara worked overseas for the US Department of the Treasury as an advisor to the Ministry of Finance and Economy in the Republic of Armenia. He also conducted work in the Republic of Georgia and the Republic of Latvia. He spent nine years at the Federal Reserve Bank of San Francisco auditing foreign and domestic banks and bank holding companies. He began his career at Wells Fargo Bank in Huntington Beach, CA.

Ara earned a Bachelor of Science degree in finance from San Francisco State University, is a Commissioned Bank Examiner through the Federal Reserve Board of Governors, and holds the Chartered Financial Analyst (CFA) designation. Ara also holds the Series 65 license.


Leave a comment
  • Dear Dane,
    Thank you for your question. The term to search for is “net income applicable” as mentioned in above. When you recharacterize a Roth IRA back to a traditional IRA, you must recharacterize the entire account. You cannot choose which investments within the account you want to recharacterize. If you comingled and converted a traditional IRA into a Roth IRA with an existing balance, and you want to recharacterize the conversion, you must calculate the net income applicable to determine the value that will be recharacterized back to a traditional IRA. Refer to IRS webstite and Publication 590 for instructions on how net income applicable is defined and calculated. Feel free to contact me directly if you wish to discuss further.

  • I have a question that I have not seen addressed in my searching. If I converted a traditional IRA to a Roth now, and made significant gains, could I then reconvert the original amount back to my IRA by Oct 17th and forgo the tax, and keep the gains in my new Roth, tax free.

    I ask because I a considering using a riskier options strategy that has the potential of much larger gains than I get with my mutual fund approach with my traditional IRA. Just for fun, if my new Roth doubled in value, could I undo my original IRA amount, forgo taxation and keep my Roth gains tax free to continue to trade my strategy, or perhaps even reconvert the IRA again the following year (assuming no rule IRS rule changes) and do it again?

    This would only be risking ~2% of my retirement portfolio, BTW.

  • Charlie,
    You cannot convert/rollover a 401k which you are an active participant. However, you can inquire with your employer to see if they offer a Roth 401k and make contributions into the Roth 401k. Once you leave your employer, you can rollover your old 401k into a traditional or Roth IRA. Feel free to contact me directly if you need additional assistance.

    Ara Oghoorian

  • Lon,
    Thank you for the great question. This article illustrates a simple Roth IRA conversion and recharacterization without excess contributions. If excess contributions are made, then NIA must be accounted for. I hope that answers your question. Feel free to contact me directly if you need additional assistance.


  • Ara,

    Does NIA (net income attributable) need to be calculated and accounted for on this kind of recharacterization? I would think so, but the custodian I use tells me it isn’t necessary….


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