IRA Recharacterization Basics
Presented by Michael G. Wendlandt:
Traditional and Roth IRAs offer great benefits, but knowing which of these retirement savings vehicles to use (and when) can be confusing. Did you make an annual contribution to your traditional IRA and then realize you should have made a Roth IRA contribution instead?
A recharacterization may be the solution. Here’s an overview of what a recharacterization is and the IRS requirements for recharacterizing IRA contributions.
IRA contribution recharacterization
Contribution recharacterization involves changing the initial designation of a contribution from one type of IRA to another—that is, switching a traditional IRA contribution to a Roth IRA contribution or vice versa. You might make a contribution to a Roth IRA and then recharacterize it as a traditional IRA contribution in order to claim a tax deduction on the amount. Or, if you’re ineligible to receive a deduction on a traditional IRA contribution, you may decide you’d be better off putting that amount into a Roth IRA, assuming your income doesn’t fall outside the phaseout limits.
Roth conversions are no longer eligible for recharacterization
In the past, you could use a recharacterization to undo or reverse a previously processed Roth conversion. That is no longer the case. The IRS no longer allows Roth conversion contributions processed on or after January 1, 2018, to be recharacterized.
When recharacterizing, you’re responsible for calculating and reporting any earnings, or negative earnings, on the recharacterized amount, according to an IRS formula:
Net Income = Contribution x (Adjusted Closing Balance – Adjusted Opening Balance) ÷ Adjusted Opening Balance
This calculation isn’t necessary if you’re recharacterizing the full amount of the contribution
and no other money has been transferred into or out of the account. For instance, if you were to recharacterize all of a $5,000 Roth IRA contribution to a traditional IRA contribution—assuming that no other transactions had taken place within the Roth IRA and no other contributions had been made to the account—you wouldn’t need to perform the calculation.
You have until your tax-filing deadline, including extensions, to recharacterize an IRA contribution. If you file your return on time, you will receive an automatic six-month extension to recharacterize the contribution.
What’s the best move?
As you can see, there are many factors to consider, including potentially significant tax implications, when deciding whether to recharacterize IRA funds. Be sure to seek the advice of a tax professional or reach out to our office to determine the best strategy for your situation.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.
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Michael G. Wendlandt is a financial advisor located at Global Wealth Advisors 207 That Way B-3, Lake Jackson, TX 77566. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA / SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth. He can be reached at (979) 849-4700 or at email@example.com.
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