Ins and Outs of Roth IRA Recharacterizations

IRA contributions can get tricky when you start to near the income thresholds as stated by the IRS. Life changes like a significant raise, marriage (and additional income) and others can move household income to limits quicker one sometimes realizes. A change to income can limit the ability to deduct the contribution and make Roth contributions. For information on income limits, always refer to the IRS:

But what do you do if you already made your contribution for the year and you realize your income will be over the limits?

An IRA Recharacterization can be either:

Undoing a contribution to a Roth IRA, or
Converting a traditional IRA contribution to a Roth IRA

Both of the above actions are referred to by tax folks as a “recharacterization.”

You can still recharacterize a contribution to a Roth IRA

Under current tax law, converting a traditional IRA to a Roth IRA cannot be reversed. This is due to a change instituted by the Tax Cuts and Jobs Act (TCJA). As if life and taxes weren’t confusing enough, even though you can no longer recharacterize a Roth conversion, you can still recharacterize a contribution to a Roth IRA.

Considerations for recharacterizing a completed Roth IRA contribution:

• The deadline for recharacterization is October 15 of the year following the year of your contribution. For example, if you contributed to a Roth IRA on April 1, 2021, your recharacterization deadline would be October 15, 2022 (the extended filing deadline for individual returns). People who miss the deadline could still recharacterize their contribution if they got a private letter ruling from the IRS.

• The only way to execute a recharacterization is through a trustee-to-trustee transfer. You cannot use a 60-day rollover to recharacterize a contribution.

• Note the difference between the recharacterized amount and the total funds transferred. The recharacterized amount is the total dollar amount of the contribution you wish to undo. But the total funds transferred must also include the earnings (or losses) attributable to the recharacterized amount. Therefore, you will need to know both amounts when you fill out your federal income tax return for the year of the recharacterization.

• Do some research to determine any rules your IRA custodian might have and restrictions it might impose. The Internal Revenue Code allows you to recharacterize all or just a portion of your contribution. However, the custodian’s policies may require the total contribution to be recharacterized. You might also find additional restrictions if your Roth invests in annuities or other contractual (insurance) products. A small number of custodians may also have policies that require clients to maintain a specific minimum balance in their accounts.

• Understand that you might have to file an amended return to receive any back taxes you paid at the time of the contribution. This will be the case if you recharacterize the contribution after you’ve filed your tax return for the year took place.

Information related to IRAs can now be found in the two primary IRS Publications that deal with IRAs.

Prior to tax laws reaching their current level of complexity, there was only one publication that dealt with IRAs, now there are two:

Publication 590-A, Contributions to Individual Retirement Arrangements; and
Publication 590-B, Distributions from Individual Retirement Arrangements.

Always check the IRS publications on their website(s), to be certain you are getting the most up-to-date information. Rules change frequently and can be complicated.

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten and Verity Wealth Partners. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.