reversing a Roth

I may be missing something but it seems you have answered your own question. The benefit of recharacterizing a Roth conversion is that, if the value of the secuities that are converted drops, you can avoid paying taxes on profits that no longer exist.

Would you care to comment on the "complexities" of a recharacterization? Is I understand it, as long as you set up a separate Roth to receive the conversion so that the converted funds are not comingled with existing Roth contributions the recharacterization is a simple process.

The first time you do anything it feels complex, I'd say. The reality is the recharacterization is a form to fill out, not very complex. In my case, I've converted cash or a single index. Then at tax time backed out enough to stay in the same bracket. This is for an 80+ yr old woman who I am keeping in the 15% bracket, but filling it up to the top.

Your question is with an eye toward recharacterizing if the market is down, leaving it if up. Nice strategy, same paperwork. In your case, I recommend another idea for '11. Convert into multiple Roths, even 10 accounts. Then recharacterize all but the one that's up the most. If you slice by asset class, even in a bad year something is up. 10 forms to start 9 to reverse, but the bigger bang, if bang is your goal. Joe

And even if they are commingled, the custodian should be able to back out the prorated amount for the recharacterization.

What you cannot do without having separate accounts is recharacterize specific investments. If you convert, say, $10,000 and put the proceeds into a single Roth IRA invested equally in two funds, call them fundA and fundB, and fundA goes up by $1000 while fundB goes down by $1000, you cannot recharacterize just fundB.

However, if, say, you already had $10,000 in the Roth and you converted another $10,000 from a traditional, your Roth now has $20,000 in it. Now if the total value of the Roth goes down to, say, $18,000, you cannot recharacterize $10,000. You can recharacterize half of the account, or $9000, which represents the full value of the original conversion (and thus eliminates the tax liability you'd have had on that $10,000). Now if you re-convert after doing the recharacterization, you'll have taxes due on $9000 instead of on $10,000.

If you wanted to play hedging games in case some securities go up and some go down, you could have converted your $10,000 IRA into two separate Roth IRA accounts of $5,000 each. Each account could be invested in a single security or fund. Then if one of those tanks, you could recharacterize just that one account's conversion but leave the other in place. This is what you couldn't do in the first scenario above, but you can do it if you keep separate accounts.

I can't imagine it's generally worth the hassle, though for a large enough account, it may well be worth it. I'd love to hear from folks who've actually done this or dealt with clients who've done this.

Yep. I did a conversion in 2008 into an existing Roth. In 2009 I did a recharacterization. After I filled out the form, Wells Fargo came back to me and told me what the amount they had calculated (significantly smaller) would move back into the TIRA was, and asked how I wanted it allocated. They moved one entire ETF and part of the holding in another in-kind to the traditional.

Brian

Wow, it sounds like you can really game the system that way. I always lose by paying attention to tax savings, but I do hedge already. For example it used to be that you could get an energy etf that would kind of go in opposition to an industrial etf. That is, with energy profitablity skyrocketing, the energy user companies would sag (and vice versa). I'm not going to exert my brain to think of a good hedging pair now, but they certainly would be good candidates for paired Roths.

The big limitation is the time limit for recharacterization. My understainding is that you can only recharacterize until October 15th of the year following the year of the Roth conversion.

Exactly right. But if you do the conversion in Jan of one year, that gives you until Oct of the following year - 22 months - to choose your time to recharacterize. That's a pretty good long time for your pair to diverge.

Again, though, while I've heard several folks talk about implementing such a strategy, I've never actually met anyone going through with it. In the longer-run, it's only good until you've finished all your Roth conversions, but it certainly does seem like you could manage the conversions in the most tax-efficient way possible by going through all this. Well, except for earning no income for a few years and converting only as much as you could do without paying any taxes at all, which is generally pretty unrealistic.

Another issue is the time it takes to complete the re- characterization. Its a manual operation for my brokerage due to the complexity involved. They will only guarantee completion 30 days before the deadline.

Great point. Most reversals would cluster right before 4/15 and 10/15, so check with the broker for their deadline. Schwab told me 10 days prior to April 15 was ok. And they did it in 3.

For what it's worth, when I did it at ETrade, it was done in only a day or two. I've no idea what the norm is - if that's really quick or if your brokerage is really slow. Or if your situation is particularly more complex than others.

It shouldn't be a big deal - they look at your account balance on the day you made the conversion, the balance now, prorate the amount that may be recharacterized (simple proportion - not a complex calculation) and you're done. The only things I can think of that could complicate it are if you've made additional transactions in and out of the account since then, or perhaps they don't have an easy system to allow you to choose which assets you are going to use for the recharacterization (ie. choose fund A or B or cash or what).