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Black Friday's silver lining
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April 26, 2000: 8:09 a.m. ET
Converting standard IRA to Roth helps investors take advantage of stock dive
By Ed Slott
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NEW YORK (CNNfn) - Remember Black Friday - April 14, 2000? The sharp stock market decline gave us all a scare, but there is a silver lining. This time it's in the form of a Roth IRA.
When many stocks plunged, a few shrewd IRA owners took action. First they converted their traditional IRAs to Roth IRAs. Others recharacterized -- or undid -- their 1999 Roth conversions back to traditional IRAs to get big tax refunds. Instead of panicking, they stayed calm and took advantage of the market drop. You may also be able to profit from one or both IRA tax strategies.
Roth IRA Conversion
Example: Your traditional IRA is worth $50,000. The market drops and now your IRA is worth only $30,000. Now is the time to strike. Convert your IRA to a Roth IRA and pay tax on only $30,000. When you convert to a Roth IRA, you must pay tax on the amount you are converting. The tax should not be paid from your IRA, but from other non-IRA funds. You must be eligible to convert. The only requirement is that your income does not exceed $100,000 in the year you convert. The $100,000 income limit is the same for both married and single individuals.
In this example, assuming over the long-term that the market not only comes back (as it usually does over the long-haul), but that the value of your Roth eventually exceeds the original $50,000, you're way ahead. You only paid tax on $30,000 and now all the future growth in the Roth IRA will escape income tax forever. Pretty sneaky, eh.
Roth recharacterization
Roth IRA owners can also cash in when the market tumbles. If you converted your traditional IRA to a Roth IRA in 1999, you may be in line for a big tax refund, thanks to Black Friday. You can recharacterize -- in other words, undo your Roth conversion and get your tax money back -- even if you already filed your 1999 taxes.
Example: Assume you converted your $100,000 IRA to a Roth IRA in 1999. Now, thanks to Black Friday, your Roth has declined in value from the original $100,000 to only $60,000. On your 1999 taxes, which you just filed, you have already paid tax on the full $100,000, even though the Roth IRA is currently worth only $60,000. That doesn't sound fair. It isn't. You can recharacterize your Roth conversion back to your regular IRA. This will unwind your $100,000 Roth conversion and you'll receive a refund of any tax paid on the 1999 conversion.
Ed Slott's Irahelp.com
If you are in the 28 percent tax bracket, you paid $28,000 tax on the $100,000 conversion. When you recharacterize, you'll be entitled to a $28,000 tax refund, plus any applicable state tax you paid on the same conversion. If you really wanted to keep the Roth, you can reconvert the IRA, now worth only $60,000 back to your Roth IRA as a year 2000 Roth IRA conversion, but you must wait at least 30 days from the date of the recharacterization. Also, in order to reconvert, your income for 2000 cannot exceed the $100,000 limit.
If you have already filed your 1999 taxes, no problem. You still qualify for a 1999 recharacterization. You have until Oct. 15, 2000 -- the final extended due date for your 1999 tax return -- to recharacterize your 1999 Roth conversion. If you have already filed, you'll have to amend your 1999 tax return and file Form 1040X (Amended US Tax Return) along with Form 8606, which is the tax form you must file to report the 1999 recharacterization.
If you decide to reconvert to a Roth, it will be a 2000 conversion, but you'll now only pay tax on the current lower value. In this example, that value will be only $60,000 instead of $100,000. At a 28 percent tax bracket, you'll immediately save $11,200 (28 percent of the $40,000 drop in IRA value = $11,200). Not bad! And you still have the Roth conversion you always wanted, but at a tax savings of $11,200. If the market goes back up over time (which is what we all hope), all the growth will escape income tax forever.
When the market drops and everyone else is crying, keep your IRA antennas up and use your IRA and Roth IRA to have Uncle Sam help finance your retirement. 
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