4 Good Reasons to Consider a 'Do-Over' for Your IRA

8/11/2019 4 Good Reasons to Consider a 'Do-Over' for Your IRA

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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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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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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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4 Good Reasons to Consider a 'Do-Over' for Your IRA