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8/11/2019 4 Good Reasons to Consider a 'Do-Over' for Your IRA
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Christine Benz is Morningstar's director of
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4 Good Reasons to Consider a 'Do-Over' for
Your IRA
An IRA recharacterization can help remedy a disadvantageous IRA
contribution or conversion.
By Christine Benz | 03-15-12 | 06:00 AM | Email Article
At first blush, "recharacterization" might sound like the worst kind of Internal
Revenue Service gobbledygook; as I type it, Microsoft Word doesn't even recognize
it as a word. (Notice that I chose the much more user-friendly "do-over" for my
headline.) But a recharacterization isn't as complicated as it sounds. Essentially,
it's a way to undo an IRA that you might have opened or converted, enabling you
to change a Roth IRA back to a traditional IRA or vice versa. Like tax-loss selling,
recharacterizing can be a valuable maneuver to help some investors lower their
tax bills.
There are a couple of key
situations when a
recharacterization can make
sense, including the following:
Reason 1: You weren't
eligible to contribute to that
type of IRA.
Say, for example, you opened
a Roth IRA but determined
your income was too high to
contribute to one for that tax year. (Single filers who earned more than $122,000
in 2011 and can contribute to a company retirement plan can't make a Roth
contribution for 2011; joint filers earning more $179,000 cannot make a 2011
Roth contribution, provided they can contribute to a company retirement plan.) In
that case, you'd have to recharacterize your Roth IRA as a traditional
nondeductible IRA, on which there are no income limits. If you chose to do so, you
could execute a so-called backdoor IRA at a later time by converting those assets
to a Roth account.
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od Reasons to Consider a 'Do-Over' for Your IRA http://news.morningstar.com/articlenet/article.aspx?id
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Comments 1-5 of 5 CommentsOldest First| Newest First
Reason 4: Your account has declined in value since you converted your
IRA.
Recharacterizations were particularly valuable during the bear market and might
still come in handy for those with foreign- or financials-stock-heavy portfolios that
have declined in value since they executed their conversions. That's because the
tax you'll owe after a conversion will depend on your balance at the time you
converted. If your account has slumped in value since you executed the
conversion, you might be able to lower your tax bill by recharacterizing and
converting when the markets are down. Just bear in mind the aforementioned time
limits for conversion after recharacterization; if the market shoots up before you're
eligible to convert again, you could lose your opportunity to convert at a more
fortuitous time.
If you've determined that a recharacterization makes sense for you, you might also
want to check with a tax or financial advisor to ensure that you're thinking through
the variables and correctly assessing the tax implications. It's also worth noting
that the amount you recharacterize doesn't have to equal your original
contribution or conversion amount. If you contributed $5,000 to an IRA that's now
worth $3,500, you would recharacterize the current amount. Filling out the
recharacterization forms is straightforward; you can obtain them from the
brokerage firm or mutual fund company where you hold your IRA assets. However,
you'll also have to file an amended tax return after you've executed the
recharacterization. Finally, stay attuned to the deadlines: For recharacterizations
related to contributions or conversions made for the 2011 tax year, the deadline is
the due date of your 2011 return, with extensions--Oct. 15, 2012.
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od Reasons to Consider a 'Do-Over' for Your IRA http://news.morningstar.com/articlenet/article.aspx?id
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8/11/2019 4 Good Reasons to Consider a 'Do-Over' for Your IRA
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User2009
Dec 30 2012, 7:19 PM
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jimonqa -
From the last paragraph of the article: "If you contributed $5,000 to
an IRA that's now worth $3,500, you would recharacterize the
current amount." My take is that the $3500 is re-characterized as if
the conversion never happened, and the loss occurred within the
(original) Traditional IRA. Think of it as giving you the opportunity to
(subsequently) convert to the Roth AFTER the drop in value (which is
the point, I surmise).
jimonqa
Mar 16 2012, 1:23 PM
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If I convert $5000 from Traditional to Roth, then find the value of
my Roth has dropped to $3500 and I decide to re-characterize back
to Traditional, am I stuck with paying taxes on the difference (the
$1500) or will I have successfully avoided all taxes as though I
never did the conversion?
Klarc
Mar 15 2012, 5:23 PM
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Microsoft Word does recognize 'recharacterization if you spell it
correctly. It requires a hyphen between the first e and the first c,which becomes re-characterization.
Thank you for your proliferate writing...the subjects you tackle are
more important than the accompanying punctuation.
Claudia
Mar 15 2012, 4:18 PM
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In Reason 2: ..."Just bear in mind that if you're converting after a
recharacterization, you'll have to wait 30 days after the
recharacterization or at least one year following the original
conversion, whichever is later."
Actually, I think you have to wait either 30 days, or until *the next
calendar year,* whichever is later. I went through this process inDecember (thank you, Mr. Berkowitz), so it would be good to have
the clarification.
Another thing to consider is that if you open a separate Roth account
for each fund (or security) you're converting from a traditional IRA
to a Roth, and hold that security *intact*, it makes it easier to
recharacterize should you need to. (I somehow think I learned this
from you, Christine?) Thanks.
TommyLee
Mar 15 2012, 10:06 AM
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Good article. Christine Benz identified several reasons tor
recharacterizations that I had not thought about. My wife and I willrecharacterize our Roth IRAs back to a traditional IRA if the
underlying investments (in the Roth IRA) do not sufficiently increase
in value. Especially if the investments fall in value, we will use the
Recharacertization as a "do over" so that our income tax bill is not
based on the higher amount when we first put the Roth IRA into
place.
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