Beginning in 2010, the income limits on individuals looking to roll their traditional IRA accounts into Roth IRA accounts are removed. This means that folks with an annual household income in excess of $100,000 are now able to convert to Roth IRAs. When you make this conversion, you pay tax one time on the value of the amount being rolled over. Thereafter, gains and income are tax-free, as are all future qualified withdrawals.
There are many benefits to converting a traditional IRA to a Roth IRA. However, if you decide to convert, and the market ends the year down 20% from the time you convert, your tax liability will be based on the asset value on the date of conversion. If this situation occurs, the IRS will let you to reverse the decision to convert.
This conversion reversal is called recharacterization. If the above scenario were to take place, you could reverse the transaction (recharacterize) and convert to a Roth again with a lower asset value, resulting in a lower tax bill. Depending on asset size, the difference in tax liability could be substantial.
It could be beneficial to do partial conversions into two or more separate Roth accounts, recharacterizing only some of them, if necessary. For example, if your fixed income portfolio performs poorly but equities do well, you can recharacterize only the fixed income portfolio.
If you think recharacterization would be appropriate for your Roth conversion, you will need to take action before you file your taxes for the year in which you made the conversion. With an extension, the deadline could be as late as October 15th. You will have to wait the longer of 30 days or January 1 of the following year to convert again. Please keep in mind that individual circumstances may warrant different solutions, so be sure whatever actions you take, that they fit into your overall investment objectives.