A recharacterization is the reversal of an IRA conversion, such as from a Roth to a traditional IRA, in order to benefit from better tax treatment. The Tax Cuts and Jobs Act of 2017 made it illegal to recharacterize a Roth IRA into a regular IRA.
What is the difference between an IRA conversion and recharacterization?
Taxpayers can convert their regular IRA balance to a Roth IRA in whole or in part. These conversions are viewed the same as a rollover, in that they move money from one retirement account to another, with the exception that converting to a Roth IRA has tax implications. The majority, if not all, of the money would be taxable. Take care! A conversion or rollover is almost always subject to a 60-day time limit, with steep penalties if the deadline is missed.
However, taxpayers may change their minds after contributing to an IRA, or after contributing to or converting to a Roth IRA. Tax regulations allow taxpayers to recharacterize their IRA contributions at any time before the due date of their tax return, including extensions. You can undo or reverse your rollover or contribution with a recharacterization. Keeping this in mind,
- Consider IRA conversions as a way to move money from a non-Roth IRA account to a Roth IRA account, usually with a tax consequence.
- Consider IRA recharacterizations to be a collection of specific regulations that allow you to change your mind about the type of IRA contribution you make this year. Recharacterization of a Roth conversion is not permitted beginning in 2018 as a result of the Tax Reform Act.
Are IRA Recharacterizations still allowed?
An individual’s tax-filing deadline, including extensions, is the deadline for recharacterizing an IRA regular contribution. The deadline to recharacterize an IRA contribution made in tax year 2020 for persons who filed their federal income tax return on time is October 15, 2021. An IRA owner may need to update his or her federal income tax return depending on the date of recharacterization. In addition, the Internal Revenue Service has declared numerous locations a federal disaster as a result of recent hurricanes, tropical storms, flooding, and wildfires, resulting in tax relief and an even longer deadline for impacted persons to recharacterize.
How do you recharacterize an IRA?
At the federal level, qualified distributions from Roth IRAs are tax-free. If you convert your traditional IRA, simplified employee pension (SEP) IRA, or SIMPLE IRA to a Roth IRA, federal income tax is due for the year of conversion. The taxable part of your conventional (or other) IRA is currently taxed. In exchange, you will get future Roth IRA distributions that are tax-free. Unfortunately, what appears to be a tax-wise choice now could turn into a nightmare when it comes time to submit your federal income tax return for the year. If this is the case, you may be able to reverse or cancel your conversion if the situation warrants it (and if you meet all of the necessary requirements). A Roth IRA recharacterization is a type of rescission.
You may be able to “reverse” or recharacterize normal (non-rollover) IRA contributions in addition to reversing Roth IRA conversions. In effect, a contribution to one IRA is treated as if it were made directly to a different IRA.
Caution: The treatment of Roth IRAs by state (and municipal) income taxes may differ from the federal income tax treatment. Determine the tax treatment for your state by consulting a tax specialist.
A recharacterization is when you choose to change the type of IRA contribution you make. The ability to recharacterize a contribution from one form of IRA to another is intended to assist taxpayers who change their minds or become ineligible for one type of IRA and wish to convert to another. In most cases, you can recharacterize (correct) an IRA contribution or Roth IRA conversion by transferring the amount (plus any related earnings) from one IRA to another within specific deadlines.
When an individual recharacterizes an IRA contribution, the contribution is considered as if it were never made to the original IRA; rather, it is treated as having been made (as of the original contribution to the original IRA) to the IRA to which the recharacterized funds are transferred. When someone recharacterizes a Roth conversion, it’s as if the conversion never happened, and the assets are regarded as if they never left the traditional IRA.
Consider the following scenario: On August 1, you converted a regular IRA to a Roth IRA, and on December 1, you recharacterized the conversion. From August 1, your funds will be regarded as if you had never made a contribution to the Roth IRA; they will be treated as if they were in a standard IRA. Any gains (or losses) made on the funds while they were in the Roth IRA will be treated as if they had been in a traditional IRA.
What effect do reclassified earnings and losses have on IRA contribution limits?
Any loss must be deducted from the amount recharacterized from one IRA to another. Earnings transferred with a recharacterized contribution, on the other hand, have no impact on the otherwise maximum IRA contribution limit.
Assume John makes a $1,000 contribution to his regular IRA in 2017. John decides to recharacterize his investment (plus the $50 in earnings allocable to it) to a Roth IRA before the deadline for submitting his 2017 federal income tax return. $1,050 is transferred to his Roth IRA through a trustee-to-trustee transfer. If John is otherwise eligible, he can contribute an additional $4,500 to his Roth IRA in 2017 ($5,500 if he is 50 or older by the end of the tax year). The $50 in earnings is considered to have been earned in a Roth IRA.
Losses from a recharacterized contribution, meanwhile, do not increase the contribution limit to the second IRA.
You may be able to reduce your tax bill by reversing (recharacterizing) your conversion if your IRA investments see a considerable fall after the conversion date. You must pay federal income tax on the taxable portion of your conventional IRA for the year of conversion when you convert it to a Roth IRA. The amount of income tax you owe is determined by the value of your IRA on the conversion date. As a result, if the value of your Roth IRA drops after the conversion date (for example, due to a stock market slump), you may want to recharacterize your contribution. You may also choose to reverse your conversion if you require the tax funds for another reason.
Example(s): Assume that in May, you changed your $100,000 regular IRA to a Roth IRA. Your Roth IRA is only worth $60,000 by December, having lost 40% of its value. Regardless, you’ll have to pay income taxes based on the $100,000 conversion date value. You might be able to undo or recharacterize your Roth conversion to get around this. You may be able to execute a new conversion based on the new account value after the required waiting period.
Take the following actions to recharacterize an IRA contribution or Roth conversion:
To accept the withdrawn IRA funds, you’ll either need to create an IRA or use an existing IRA. Recharacterizations with the same IRA trustee can be done by redesignating the first IRA as the second IRA rather than transferring the account balance to a new account (if the trustee allows it).
Employer contributions (including optional deferrals) under a SEP-IRA or SIMPLE IRA plan cannot be reclassified as contributions to another IRA. You can recharacterize contributions made to a SEP-IRA or SIMPLE IRA into a SEP-IRA or SIMPLE IRA if you converted them to a Roth IRA.
You must tell both financial institutions—the one servicing your current IRA and the one that will accept the recharacterized funds—that you intend to perform a recharacterization if more than one is involved. (If both IRAs are held by the same trustee, only one notification is required.) If you transfer funds without receiving this warning, the recharacterization may be nullified. The notice must be delivered on or before the transfer date.
Caution: In most cases, a proper recharacterization of IRA funds requires a direct transfer (either trustee-to-trustee or custodian-to-custodian). Within 60 days, you can’t remove money from your IRA and roll it over to a new IRA; the monies must be moved straight from one IRA to the other.
In most circumstances, you can recharacterize your contribution online or using the usual form provided by your IRA provider. If your IRA provider doesn’t offer a standard recharacterization form, you should speak with a tax specialist to establish one. All required information should be included in your form, including the following:
- “Notice of Election to Recharacterize IRA Contribution/Conversion,” for example, would be an appropriate heading.
- Name, address, phone number, IRA account number, and Social Security number are all required.
- The first IRA trustee’s name and the second (new) IRA custodian/name. trustee’s
- The type and amount of the initial IRA contribution that you want to recharacterize now. Notify the initial IRA trustee that you want your contribution recharacterized, along with any net income (or net loss) allocable to that contribution. (For further details on determining net income/loss, see the section below.)
- The year in which the first IRA contribution was made, as well as the date on which it was made (if applicable)
- A statement to the first IRA custodian/trustee that you desire to make a direct, trustee-to-trustee/custodian-to-custodian transfer of money from your current IRA to a new IRA by a certain date. (Include the new IRA account number, as well as the new IRA custodian/name, trustee’s address, and phone number.)
Both IRA custodians/trustees should get a copy of your recharacterization notice. You should also follow up with each of them to make sure the transfer is completed on schedule.
The due date of your federal income tax return for the year of the initial contribution, including extensions, is the deadline for recharacterizing an IRA contribution or Roth IRA conversion. (The original contribution year refers to the year to which the contribution relates, not the year in which the contribution was made.) If you file for an automatic extension, you have until October 15 to recharacterize a prior-year contribution.
But what if you submitted your tax return before April 15 and now wish to recharacterize a Roth IRA contribution? You would have already paid the conversion tax in this scenario. Even if you filed your tax return on time and didn’t get a filing extension, you can recharacterize your Roth IRA contribution up until October 15 provided you follow an unique procedure. You must file an amended return (IRS Form 1040-X) and write “Filed according to Section 301.9100-2” on the return to take advantage of this provision. Any tax you paid on the conversion will be refunded to you. A new or revised Form 8606 must also be included.
Caution: You can only use this unique process if your income tax return was filed on time (i.e., either by April 15, or within the extension period if you filed for an extension in a timely manner).
The modified return date should not be confused with the recharacterization due date. It is possible to file an amended return up to three years after the initial return was filed. However, the deadline for recharacterization (i.e., moving) of your Roth IRA assets is October 15 of the year after your April 15 tax-return-filing deadline.
You may be required to attach Form 8606 and a statement explaining the recharacterization if you elect to recharacterize a contribution (either on your federal income tax return or on an amended return). The recharacterization must be reported on the tax return for the year in which the initial donation or Roth conversion was made. For more information, see the instructions for Form 8606.
When you recharacterize an IRA contribution, you must transfer the contribution to a new IRA, together with any profits that are allocated to that contribution.
Tip: Using a new Roth IRA (rather than an existing Roth IRA) to hold each conversion makes it easier to determine the amount (particularly, the allocable profits) you’ll need to send back to the traditional IRA if you choose to recharacterize (reverse) a conversion. It can also make sense to set up individual Roth IRAs for each investment you want to make. (After the recharacterization date has gone, you can always combine two or more of your Roth IRAs.)
If you only wish to recharacterize the contribution and earnings in your IRA, you can simply recharacterize (transfer) the entire IRA. When you recharacterize your IRA, you don’t have to make up for any losses that have occurred since the original conversion.
If you’re simply recharacterizing a piece of an IRA, you’ll need to figure out how much of the IRA’s earnings belong to the part you’re moving and how much to the rest of the IRA. Here’s how to calculate net income (notice that it can be negative):
For this calculation, the beginning balance is the account’s fair market value (FMV) right before the contribution was made, and the closing balance is the account’s FMV right before the contribution is removed. The “adjusted opening balance” is the opening balance plus any contributions or transfers to the account during the computation period (including the amount being recharacterized). The closing amount plus any distributions (including recharacterizations) made from the account during the computation period is the “adjusted closing balance.”
Assume John owns a Roth IRA with a value of $50,000 as of February 1, 2016. John intends to convert $100,000 from a regular IRA to his existing Roth IRA on the same day. John discovers that his income level will make him unable to make a Roth conversion contribution in 2016 before filing his federal income tax return for 2016. As a result, he proposes that the $100,000 be recharacterized to his regular IRA on February 1, 2017. On that date, when John’s Roth IRA is valued $135,000, the Roth IRA trustee transfers the $100,000 contribution plus allocable net income to John’s traditional IRA.
Here’s an example of how to compute allocable net income. The account’s adjusted opening balance is $150,000 ($50,000 + $100,000), while the account’s adjusted closing balance is $135,000 ($50,000 + $100,000). As a result, the net income (or loss) attributable to the $100,000 contribution is -$10,000. The Roth IRA trustee must transfer $90,000 ($100,000 – $10,000) from John’s Roth IRA to his traditional IRA to recharacterize John’s $100,000 conversion contribution.
Different requirements may apply if more than one donation is being recharacterized. If more than one contribution is eligible for recharacterization in a given year, the IRA owner chooses which one to recharacterize. If a series of regular contributions had been made and subsequent contributions in that series were recharacterized, the computation period would be computed using a single calculation period (based on the first contribution in the series). Consult a tax specialist for further details.
Technical Note: The amount of net income to be transferred may be calculated for you by your IRA provider. If your provider is unable to assist you, please refer to IRS Notice 2000-39 and IRS Regulation Section 1.408A-5.
How long must you wait before converting or rolling over your funds to a Roth IRA?
If you convert assets to a Roth IRA and subsequently recharacterize them to a traditional IRA, you’ll have to wait a long time before you can convert those funds back to a Roth IRA. You can’t convert and reconvert an amount within the same taxable year, or within the 30-day period after a recharacterization, whichever comes first. If you try to convert during one of these times, the conversion will fail.
Assume you switched from a regular IRA to a Roth IRA in May of 2017. You convert the Roth IRA to a regular IRA on August 7, 2017. You’d like to switch back to a Roth IRA. You won’t be able to perform a reconversion unless one of the following events occurs:
- January 1, 2018 (the first day of the year after the year in which the money was first transferred to a Roth IRA), or
- 7th of September, 2017 (the end of the 30-day period following the day on which you recharacterized the Roth IRA to a traditional IRA)
Because it’s the later of the two dates that counts, you’ll have to wait until at least January 1, 2018 to convert.
Assume that in May of 2017, you converted a regular IRA to a Roth IRA. You convert the Roth IRA to a regular IRA on December 7, 2017. You’d like to switch back to a Roth IRA. You won’t be able to perform a reconversion unless one of the following events occurs:
- 7th of January, 2018 (the end of the 30-day period following the day on which you recharacterized the Roth IRA to a traditional IRA)
You’ll have to wait until at least January 7, 2018, to convert because the later of the two dates is what matters.
[This data, compiled by a third party, was collected from sources deemed to be credible, but we do not guarantee its accuracy.]
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Is a recharacterized IRA taxable?
Recharacterizations are not taxable, but they must be reported to the IRS using IRS Forms 1099-R and 5498. The IRS must also be notified of the original contribution or conversion. When it comes to making a yearly contribution to a Traditional or Roth IRA, the process can appear to be rather simple.
Does a recharacterization count as a contribution?
- There is a recharacterization deadline. The deadline for submissions is October 15th of the year after the year in which they were made. Your recharacterization date would be October 15, 2022, if you contributed to a Roth IRA on April 1, 2021. People who miss the deadline can still recharacterize their contributions if they obtain a private letter ruling from the IRS, but this is a lengthy and costly process.
- A trustee-to-trustee transfer is the sole way to complete a recharacterization. A 60-day rollover prevents you from doing so.
- Keep track of the difference between the total monies transferred and the recharacterized amount. The total monetary amount of the gift you want to undo is the recharacterized amount. The earnings (or losses) related to the recharacterized amount must, nevertheless, be included in the total amounts transferred. It’ll assist you fill out your federal income tax return for the year of the recharacterization if you’re aware of the difference.
- Be aware of any special policies and limits that your IRA custodian may have. While the Internal Revenue Code allows you to recharacterize your contribution in whole or in part, the custodian’s regulations may not be as accommodating. If your Roth is invested in annuities or other contractual assets, you may face restrictions. A requirement to maintain a specified minimum balance in your account is another custodial policy that could interfere.
- You should be aware that you may need to file an updated return to recover taxes you paid at the time of the contribution. If you recharacterize the contribution after you’ve filed your tax return for the year in which it occurred, this is the case.
The IRS Publications on IRAs provide all of this information, as well as a lot more. There was just one publication that dealt with IRAs before tax regulations reached their current degree of complexity; currently there are two: Contributions to Individual Retirement Arrangements (Publication 590-A); and Distributions from Individual Retirement Arrangements (Publication 590-B). You may be sure you’re getting the most up-to-date information by checking the IRS publications on their website.
It is conceivable to acquire a billionaire through compounding a middle-class or upper-middle-class salary over a long enough time horizon, combining constant substantial contributions and decent long-term stock gains during the period, including most occupations in federal service.
Can you undo a recharacterization?
To recharacterize an account back to traditional IRA status after a conversion, you must submit the necessary form to your Roth IRA trustee or custodian by October 15 of the year after the conversion. The deadline is the following Monday if October 15 occurs on a weekend. This adaptability adds to the appeal of the conversion concept.
If you’ve already submitted your tax return for the conversion year, but it isn’t yet October 15, you still have time to reverse the conversion (with extra days in years when October 15 falls on a weekend). You would then need to file an amended tax return (using Form 1040X) by the due date for amended returns to obtain back the tax you paid on the conversion. (You usually have three years from the date you filed your initial return to seek a refund from reversing a Roth conversion, but you shouldn’t wait that long.)
How does a recharacterization work?
Recharacterizations and conversions are practically the same thing when it comes to IRAs. A conversion is the process of transferring assets from a regular IRA (or another type of pre-tax retirement plan) to a Roth IRA. A recharacterization is the process of reversing a conversion (or rollover). Tax considerations play a role in both actions.
The delayed tax deadline of Oct. 15 was the date for converting a regular IRA (or other retirement plan) to a Roth IRA conversion. You could treat any contribution as a traditional IRA contribution if you met the deadline (not taxed).
If you converted in 2019, for example, you would have had until October 15, 2020 to complete a recharacterization. If you had already filed taxes for the conversion year, you might revise and submit a new tax return. You would have to wait 30 days or the next calendar year (whichever is longer) after recharacterization to convert to a Roth IRA.
What is a nondeductible IRA?
Any money you put into a standard IRA that you don’t deduct on your taxes is a tax deduction “contribution that is not tax deductible.” You must still record these contributions on your tax return, and you do so using Form 8606.
You will save money in the long run if you report them. This is because no one’s money should be taxed twice by the federal government. It’s on Form 8606 that you’ll find it “on the record” that a portion of your IRA’s funds have already been taxed. When it comes time to take distributions, a portion of the money you receive will be tax-free.
Is recharacterization the same as conversion?
Recharacterize and convert may appear to be similar phrases when it comes to doing something with a Traditional or Roth IRA, but they have quite different meanings. They’re both about change. You’re changing something when you recharacterize. You are also changing something when you convert. But don’t get the two mixed together. You could face tax penalties if you inform your IRA custodian to recharacterize when you wanted to convert.
Convert works with a fixed balance, or a pile of cash, if you will. The funds are held in a Traditional IRA. It’s transferred to a Roth IRA. That’s how you convert. It is a one-way road. A Roth IRA cannot be converted to a Traditional IRA. You can convert whenever you want because convert works on a static balance. The money is always available for conversion.
Recharacterize is a function that performs on an action. A contribution, which is an action, can be recharacterized, as can a conversion, which is also an action. You have a deadline to impact the action because it operates on an action. The original action becomes permanent if you do not recharacterize before the deadline.
When you recharacterize, you’re indicating that you previously did X, but now that I think about it, I’d rather do Y. If you contributed to a Traditional IRA but then changed your mind, you can recharacterize the contribution as a Roth IRA contribution if you do so before the deadline (if you otherwise are eligible to contribute). It also works the other way: if you contributed to a Roth IRA but then changed your mind, you can recharacterize the contribution as a Traditional IRA contribution within a certain time frame. If you converted from Traditional to Roth but then changed your mind, you can recharacterize and undo the conversion within a certain time frame.
Because your income is too high to contribute to a Roth IRA, you made a non-deductible contribution to a Traditional IRA. If you said recharacterize instead of converting that Traditional IRA to a Roth IRA, you’re now in danger. Your IRA custodian isn’t aware that you aren’t qualified for Roth contributions to begin with. They will follow your instructions. Your recharacterized donation will result in a penalty at tax time.
Don’t get the terms convert and recharacterize mixed up. In the word recharacterize, the letter ‘a’ stands for activity. Convert works with a large sum of money and has no deadline. Recharacterize is a timed action with a deadline.
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Can you recharacterize a recharacterization?
The IRA Recharacterization Form below can be used to complete most recharacterizations. You can also get live assistance by calling 800-205-6189 and speaking with one of our expert retirement specialists. Remember that if you convert to a Roth after December 31, 2017, you won’t be able to convert back to a standard IRA later.
How do I report Roth IRA recharacterization on tax return?
You contributed to a traditional IRA and later recharacterized part or all of it to a Roth IRA through a trustee-to-trustee transfer. Report the nondeductible traditional IRA portion of the remaining contribution, if any, on Form 8606, Part I, if you only recharacterized a portion of the contribution. Don’t report the contribution on Form 8606 if you recharacterized the entire amount. In either scenario, include a statement explaining the recharacterization with your return. Include the amount transferred from the conventional IRA on Form 1040, 1040-SR, or 1040-NR, line 4a, if the recharacterization occurs in 2020. If the recharacterization took place in 2021, just record the amount transferred on the attached statement, not on your 2020 or 2021 tax returns.
What is a recharacterization of a contribution to a traditional or Roth IRA?
A recharacterization lets you to treat a regular contribution to either a Roth or a traditional IRA as if it were made to the other. A regular contribution is the maximum amount you can put into a traditional or Roth IRA each year: $6,000 in 2020-2021, $7,000 if you’re 50 or older (see IRA Contribution Limits for details). It does not include any type of conversion or rollover.
How do I recharacterize a regular IRA contribution?
You tell the trustee of the financial institution holding your IRA to transfer the amount of the contribution plus earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a different type of IRA with the same trustee to recharacterize a regular IRA contribution. You can treat the contribution as made to the second IRA for that year if you do it by the due date for filing your tax return (including extensions) (effectively ignoring the contribution to the first IRA).
Can I recharacterize a rollover or conversion to a Roth IRA?
A conversion from a regular IRA, SEP, or SIMPLE to a Roth IRA cannot be recharacterized as of January 1, 2018, under the Tax Cuts and Jobs Act (Pub. L. No. 115-97). Recharacterizing money rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans, is also prohibited under the new rule.
How does the effective date apply to a Roth IRA conversion made in 2017?
If the recharacterization is completed by October 15, 2018, a Roth IRA conversion made in 2017 can be reclassified as a contribution to a traditional IRA. It is not possible to recharacterize a Roth IRA conversion completed on or after January 1, 2018. For more information, see Publication 590-A, Contributions to Individual Retirement Arrangements, section “Recharacterizations” (IRAs).
Because this FAQ does not appear in the Internal Revenue Bulletin, it cannot be used as legal authority. This means the data cannot be used to support a legal claim in a court of law.