ReCharacterization of IRA Contributions or Roth Conversions

Recharacterization is when a 401k participant switches from a Traditional IRA plan to a Roth IRA plan, and due to various # of reasons, switches back to the Traditional IRA plan. When making IRA recharacterizations, individuals have to calculate their earnings and losses on the original value of their Roth Conversions or IRA contributions. It is imperative that these earnings/loss calculations are done correctly otherwise the tax consequences can be severe.

First, the deadline for Recharacterization of a Roth Conversion of IRA Contribution is your tax-filing deadline (April 15th of each year). However, you are eligible to receive a 6 month extension on Recharacterizations which means your deadline is Oct 15th of each year. For example, if you want to Recharacterize a 2004 IRA contribution you made, your deadline is October 15th, 2004.

Why Would I want to Recharacterize my Roth Conversion?

A taxpayer can choose to recharacterize his Roth Conversion for reasons such as:

  • Previous Roth Conversions were ineligible and failed
  • Value of retirement assets have decreased since the Roth Conversion*
  • Individual has a change of mind and wants to switch back to a Roth IRA

* For example, when Roth IRA assets are converted, the taxable amount of the conversion is the initial value when the assets are converted, even if these assets have declined in value. For instance, if a taxpayer converted his IRA assets worth $120,000 in April of 2004, and these assets have since decreased in value to $40,000, the individual will still have to pay taxes on the initial $120,000 he deposited in April of 2004. Who said tax rules are fair!?

Why Would I want to Recharacterize my IRA Contribution?

A taxpayer can choose to recharacterize his IRA Contribution for reasons such as:

  • An individual can recharacterize his Traditional IRA contributions into Roth IRA contributions due to tax-free accumulation and accrual of earnings.
  • An individual can recharacterize his Roth IRA into a Traditional IRA in order to be eligible to make tax deductions on the amount.

How Do I Recharacterize my Roth Conversion of IRA Contributions?

In order to recharacterize your IRA, you must move all the retirement savings and assets from the original IRA into your new IRA plan. Your financial institution can simply do this move by changing the type of IRA, for example from a Traditional IRA into a Roth IRA. Check with your financial institution as to their requirements, plus all the documentation you will need to successfully recharacterize your IRA.

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