When a traditional IRA owner wants to convert all or a portion of his account to a Roth IRA, he needs to think long and hard about the transaction. For example, some questions to consider:
1. When will this money be needed? Since the earnings on a conversion must remain untouched for 5 years AND the Roth IRA owner must be age 59 ½ before those earnings are tax-free, conversion is a long-term play.
2. What will future tax rates be? If they are anticipated to remain level or go up, then converting now could be a viable solution. But if rates are expected to go down, then it might be wise to reevaluate and possibly postpone a conversion.
3. Where will the money come from to pay the taxes on the conversion? It is often recommended that a person pay the taxes from another source, other than having taxes withheld from the IRA. This way the full amount can begin to grow tax-free.
Why are these foundational questions so important? Because there is no going back. As soon as you hit ENTER on your computer, or as soon as your financial advisor submits the transaction, the deed is done. It cannot be unwound. Recharacterization of a Roth conversion is off the table. (Congress did away with it back in 2018.) Whatever consequences that follow a conversion must be dealt with. Since a Roth conversion is such a major decision, and since conversions are so popular, the common advice is, “Be sure this is what you want to do, because recharacterization is no longer an option.”
This is 100% true – recharacterization is no longer allowed. That is, as it pertains to Roth conversions.
HOWEVER, recharacterization of a traditional IRA or Roth IRA CONTRIBUTION is still available. This is a common misunderstanding. Yes, an unwanted or ineligible contribution to one type of IRA can be recharacterized (changed) to another type of IRA. A traditional IRA contribution can be recharacterized to a Roth IRA, or vice versa. A contribution can be recharacterized for any reason as long as it can be a valid contribution to the other type of IRA.
Why would it be necessary to recharacterize a contribution? Maybe a person made a Roth IRA contribution, but then later in the year earned a big year-end bonus which pushed her over the Roth IRA phase-out limits ($230,000 – $240,000 for those married filing joint in 2024; $146,000 – $161,000 for single filers). Maybe a person made a traditional IRA contribution, but then learned that the contribution could not be deducted based on participation in a work plan.
Regardless of the reason, a traditional or Roth IRA contribution can still be recharacterized. But there is a deadline – October 15 of the year after the year for which the contribution is made. Beyond that drop-dead date, recharacterization is not available. Recognize that when processing a recharacterization, any earnings or losses applicable to the contribution must also be recharacterized. (For example, if you made a $5,000 contribution that was now worth $4,500, only $4,500 gets recharacterized.) Ultimately, it will be as if the original contribution was made to the proper IRA.
While the term “recharacterization” is often dismissed because it “does not exist anymore,” it is imperative to understand that recharacterization is alive and well…but only as it pertains to Roth or traditional IRA contributions.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
Specializing in private wealth management, we provide education, guidance, and strategies to help you achieve a tax-efficient retirement income.
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