3 Ways To Reduce The Risk of a Roth IRA Conversion

With the new conversion opportunity made available by the passage of the Small Business Jobs Act of 2010 (see New Opportunities to Roth), there is one factor that is not available that you normally have when doing Roth conversions: recharacterization.

If you recall, the primary reason that you would want to recharacterize is if you converted funds and then, by the time you pay the tax, the holdings that you converted have dropped in value.  So, instead of paying tax on something that is much less in value than previously, for a Roth IRA conversion you can recharacterize the conversion up to October 15 of the following year (see Help Mr. Wizard – I didn’t wanna do a Roth Conversion for more details on recharacterization)

But there are ways to reduce the risk associated with your Deemed Roth Account Conversion (since you are not eligible to recharacterize the conversion).

1.) For one thing, you could use dollar-cost averaging to spread the risk of market fluctuations over several points in time through the year.  Simply split your intended conversion amount into four amounts, and convert one of those amounts each quarter, for example.  This way if the market drops through the year, you’re converting funds at the lower values.

2.) Another option would be to spread the date-specific risk over several years, by converting smaller amounts each year.  This would also reduce the risk of adverse market results, and spread out the tax over several years (if possible).

3.) Yet another choice could be to convert only those assets that have very low volatility, such as bonds.  The probability of a major drop in value is much lower for these assets, so your need for a recharacterization would be far less likely.

There are many other, more complicated ways to reduce your risk against such a situation, but these are a few that are easily implemented.  Hopefully this will help you in your process of converting retirement plan assets to Roth.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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  • Kishan –

    How is the $15,000 taxed? If $5,000 comes from the Roth, there is no tax. If the remaining $10,000 comes from the deferred accounts, all of it will be taxed as ordinary income.

    I’m not sure where the confusion lies… anything that goes into the Roth (including growth) is tax free as long as the holder is over age 59 1/2 and the account has been established for at least 5 years (and any conversion was five years ago).

    In the example you gave, $30,000 of the Roth (plus the growth) would have been converted less than five years prior since he’s converting $6,000 per year, but the distribution order would require taking the earlier converted money out first.

    Hope this helps –


  • Hello Jim,
    In all the articles I have read in FIGUIDE and IRS on-line code I could not get a straight answer…. Can you please clarify that for me… Thanks.

    Client has:
    100,000 in either SEP or 401K plan and also has
    30,000 in Traditional contributary (deductible) IRA … from previous employer.

    Client NOW wants to start a NON-Deductible IRA… Start contibuting 6000/yr (age 50+ yrs) and converts it to ROTH IRA immediately, just 6000…. Lets say he does that for 10 years… now retires:

    SEP/401k has ………. 150,000 (100K basis +50k Growth)
    traditional IRA ……. 50,00 (30K basis + 20k Growth
    Roth has ………….. 100,000 (60k basis + 40k Growth)

    He draws 15,000 /year if he draws 5k from each bucket how is the money taxed?

    Can the client draw 40k Roth Growth TAX Free?

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