When to recharacterize a Roth IRA

You might want or need to recharacterize your Roth IRA conversion for several reasons:
1.  You simply don’t have the money to pay the taxes due on the conversion.

2.  The market dropped sharply after you converted to a Roth. Let’s say you converted $100k into an S&P 500 index fund in February 2008. By October 2009, it would have dropped to around $78,500. To avoid being taxed on a conversion of $100k, you could have extended your return until 10/15/09, hoping the market would recover. Since it was still down at that point, you would have recharacterized to “undo” your initial conversion.

3. You converted into multiple Roth IRAs segregated by asset allocation. For example, you might choose to convert international funds into one Roth IRA, small-cap funds into another, and REIT funds into a third Roth. Should small-caps have a great year, but not internationals and REITs, you could recharacterize the IRAs that dropped (int’l and REITs), but not the account that grew (small-caps).

4.  You have converted to a “back-door” Roth IRA during the year and will also have a pre-tax IRA balance under your name as of the end of the year. This could be because an old 401k made a forced IRA rollover to you or because you rolled out to a pre-tax IRA sometime earlier in the year then learned all about back-door Roth IRAs and decided to take advantage. What matters is what you have in your name as of the last day of the year, not the order in which these events happened during the year. In this event, you would want to recharacterize the back-door back to a nondeductible IRA.

5. Finally, if the conversion put you into an unexpectedly higher tax bracket. Maybe you have unplanned-for 1099 income and the Roth conversion moved you into a higher tax bracket. In this situation, you could recharacterize just enough to move down a bracket and perhaps eliminate other taxes that have been triggered, such as the extra Medicare tax.

Do you have recharacterization questions? Post below and I’ll be sure to answer!

What is a Roth recharacterization?

Roth recharacterization rules

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