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Can I reverse a Roth conversion?

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Q: If I convert an amount from my traditional IRA to a Roth, keeping me in a low tax bracket, and my financial adviser sells a bunch of stocks, leading to an unexpected gain that bumps me into a higher tax bracket, can I return the money to the traditional IRA to limit the tax liability for the year?

A.: Sorry to be the bearer of bad news, but the answer is “no.”

In 2018, as part of the Tax Cut and Jobs Act, “recharacterization” of Roth IRA conversions from traditional IRAs and qualified plans (e.g., 401(k)) were no longer permitted. As a result, all Roth conversions taking place on or after Jan. 1, 2018 are irrevocable.

Recharacterizing Roth contributions is still permitted. This would be the choice if you were to make a regular contribution (up to $6,000 for 2020, $7,000 if over age 50) to the wrong type of IRA and wanted it switched to the correct account.

The scenario you describe can be avoided with good communication and coordination. Talk to your adviser about the conversion before you execute it. Be aware though that while most “advisers” will talk about taxes, they will have a disclaimer that states that they don’t give tax advice. Many work at firms that prohibit them from preparing even the most basic tax projections. Some can critique a projection you create, but are still likely to avoid standing by any such critique. They will say, “see your tax adviser.” You should follow that suggestion, especially if you are not working with a financial planning and advisory firm that gives tax advice, coordinates the tax planning with the investments and stands by their tax advice.

It is easy to have the issue you describe even if you don’t use an adviser. Recharacterizations of Roth conversions were a staple of tax planning for years so one could be unaware of the change. A conversion done earlier in the year can easily be forgotten when placing trades later in the year. A Roth conversion was a tactic touted frequently around the COVID-19 crash.

Getting bumped to a higher bracket is also possible without placing a trade at all. For instance, you could receive a bonus at the end of the year. Further, mutual funds must pay out net realized capital gains every year. Most of these capital gain distributions are paid in the fourth quarter. If funds you own pay out enough capital gain distributions, one can easily find their income higher than expected and desired effect of a Roth conversion diminished.

Converting IRA money to a Roth IRA when in a low tax bracket is a sound tax strategy. In most years, it is usually advisable to wait until the end of the year to execute a conversion because you can use more actual numbers than estimated numbers for income items when projection your taxes and have higher assurance that you will remain in a low bracket.

In years like 2020 when the market declines early in the year and you think a Roth conversion is appealing, one option is to err on the conservative side and convert some but not all of what you think you will want to convert in the year at that time. Later in the year, if in fact your income is low enough to make further conversions attractive, you can convert more at that time. The more you convert, the more tax revenue Uncle Sam collects so there is no limit to the size or number of conversions executed during the year.

If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.

Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some questions are edited for brevity.



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‘I could live on my Social Security and still save money’: This 66-year-old left Chicago for ‘calming’ Costa Rica — where he now plans to live indefinitely

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Editor’s note: This article was first published in September 2019.

A school break changed 66-year-old Martin Farber’s life forever.

In 2007, his daughter — who at the time was attending Illinois State University — decided she wanted to spend a college holiday volunteering in Costa Rica and staying with a local family, he explains. She came home raving about the experience, so, in 2008, Farber — who at the time was living in Evanston, Ill., just outside Chicago, and selling cars — took his first trip there.

“It was a big surprise to me — bumpy roads, dogs barking in the streets,” he says. “I wasn’t enamored at first.”

But as his daughter began traveling there more and eventually moved there for a year, he took additional trips to Costa Rica. It quickly grew on him — in particular, the people. “The Costa Rican people are warm, open and friendly. I felt less invisible in a strange country in a strange town where I didn’t speak the language than I did in Evanston.”

And the more time he spent there, the more it impacted him: “On one of my trips there, I thought: My daughter’s life makes more sense than mine,” he says. “There was nothing wrong with my life, but I felt that my life was out of context with who I’d become. … I would have bills and make money to pay them, but that had ceased to be satisfying,” he recalls. “I knew I needed to change my life — there was no more joy in what I was doing.”

What’s more, when he’d return from his Costa Rica trips, people noticed. “I would come back, and my friends and therapist would say: You seem better after you go,” he says with a laugh.

A view from the hot springs near Martin Farber’s home in Costa Rica.


Martin Farber

So in 2014, he packed up and moved to Orosi — a picturesque, lush small town with waterfalls and hot springs a little over an hour’s drive from San Jose — promising himself he’d stay for two years. It’s been five, and he now plans to stay in Costa Rica indefinitely. (Though Farber notes that, to him, “it’s not a retirement; it’s a chance to lead a new and different life.”)

Here’s what his life is like, from costs to health care to residency to everyday life:

The cost: While many expats spend way more living in Costa Rica, Farber says: “I could live on my Social Security and still save money.” He says “a person can live on $1,200 per month, two people on $2,000.” The key, he says, is to live more like he does and as the Costa Ricans do — in a modest home, eating local food and purchasing local goods.

Indeed, Farber himself spends just $300 a month for rent (he rents a home from a friend who moved recently and gave him a good deal), roughly $225 a month on groceries and just $50 a month total on water and electricity (the temperate climate in Orosi means you rarely need heat or air conditioning). The veteran Volkswagen
VOW,
+0.96%

 
VLKAF,
+0.98%

salesman saves money by not owning a car (those over 65 ride municipal buses for free), which can be a significant expense in Costa Rica; for his cellphone, “I pay as I go … roughly $10 may last me a couple weeks or more,” he says, adding that “many people handle there their cellphones this way. You can get them recharged anywhere.”

His major expense is travel: He goes back to the U.S. to visit his mother in Florida several times a year and lately has spent part of the summer in Chicago helping out a friend with a dealership there. He also spends a good amount of money on health care. He says that while flights can be had for as little as $350 roundtrip during offseasons, the cost can be much higher the rest of the year.

In the saddle.


Martin Farber

Health care: Farber, who has permanent resident status in Costa Rica, says he pays about $90 per month to participate in the country’s health-care system — adding that the health care he’s received has been very good. (A 2018 study of health-care quality and access in more than 190 nations ranked Costa Rica No. 62.)

When he developed a detached retina, though, he paid for the procedure out of pocket so that he didn’t have to wait for the required surgery, he says — adding that the entire procedure cost him about $5,000. “I would have had to have waited four days,” he says, if he had not paid to expedite matters. “That might have been fine, but it might not.” And he adds that the quality of care depends on where you get it in the country.

Lifestyle: Though Farber says that he “moved here with no goals and no agenda,” he’s found plenty to do. “I take Spanish lessons two days a week for two hours a day. It’s been great. I never thought I would acquire a usable language in my 60s,” he says. He also rides his bike all around the area, does some writing and belongs to a community group that undertakes projects to improve the area.

And he often simply takes in nature, which he says has been an essential part of why he feels calmer and more relaxed in Costa Rica than in the U.S. “I live at 3,000 feet but in a valley surrounded by coffee fields and lime trees and water. At night, if I open the windows, I can hear the river rushing by,” he says. “It is very calming … hundreds of trees everywhere … you know the Earth is alive.”

The historic Iglesia de San José de Orosi.


iStock

Cons: “I don’t want to overglorify. It’s not without its problems,” Farber says of Costa Rica. “There are social problems and downsides.” He notes that crime and petty theft can be a problem (“I am cautious,” he says of his approach) and seem to have increased since he moved there, and adds that he misses out on some cultural things because of where he lives. And, he says with a laugh, “I can’t order Thai food at 9 at night.” But, he adds: “These are trade-offs — in the afternoon, I get to walk in the coffee fields and see flocks of parrots.”

Residency: To qualify for Costa Rica’s pensionado visa, expats must prove that they have a pension of at least $1,000 coming in each month. (Here are the details of that program.) Once you have lived in Costa Rica for three years, you can apply for permanent residency. Farber used a lawyer to help him figure out the ins and outs of residency options; his entire path to permanent residency took about a year, he says.

The bottom line: “After five years I am still amazed and surprised that I made the decision to lead a life I never thought I would,” he says. And while he may not stay in Orosi forever — “the town doesn’t have an ambulance, [and] I don’t know what it will be like to be 80 there,” he says — he does plan to stay in Costa Rica in no small part because of the people and sense of community. “I have the feeling that life is good here,” he says. “It’s hard sometimes, but we are all in it together.”



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Mutual Funds Weekly: These money and investing tips can help you read the market’s signs and stay on your path

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