Bear market's silver lining for IRAs .

• Author: Bencivenga, Joseph V.

Those brave enough to open their IRA statements have been numbed by the sight of monthly losses. While no magic wand is at hand to turn back the clock, taxpayers can make certain moves to minimize tax on their accounts and blunt the painful losses to a degree, by considering Roth IRA conversions, in light of years to retirement and risk (see Exhibit 1).

This item does not consider all possibilities. In addition, for all scenarios, it assumes (1) an IRA accountholder has invested mostly in equities and has suffered substantial losses, (2) the market has a good prospect for recovery and (3) the accountholder has sufficient years before retirement to offset taxes paid with future untaxed earnings in a Roth IRA account. (Relevant factors not explored include the effect of lower marginal tax brackets on (and during) retirement.)

Conversion to a Roth IRA

Sec. 408A(d)(3) allows an account-holder to roll over a traditional IRA to a Roth IRA account, provided that he or she includes the rollover amount in gross income and pays the income tax thereon. Given the stock market's plunge,, such a move would mean lower taxes than if the taxpayer had rolled over the account when the stock market was higher. The Sec. 72(t) penalties on premature distributions do not apply to such a Roth IRA conversion. However, (among other things), Sec. 408A prohibits a conversion of a traditional IRA to a Roth IRA if, for the tax year of the conversion, the taxpayer's adjusted gross income (excluding from gross income the potential conversion amount) exceeds $100,000.

Conversion from a Roth to a Traditional IRA

Relatively recent conversions of a traditional IRA to a Roth IRA are likely to have been made at a high tax cost. If an account's value has fallen considerably since the conversion, tax will have already been paid on the original amount. The effect of such an unfortunate situation can be compensated for by a recharacterization under Regs. Sec. 1.408A-5. Using a trustee-to-trustee transfer, the conversion could be recharacterized, if made before the due date (including extensions) for filing a Federal income tax return for the tax year in which the individual made a contribution to the first IRA (here, the Roth IRA).

Post-Filing Relief

Relief is also available for a limited time after a taxpayer has filed a return. Regs. Sec. 301.9100-2(b) allows an automatic six-month extension from a return's original due date, if the due date of a regulatory or statutory election...