Through a partial individual retirement account (IRA) recharacterization, you can lower the tax consequences of a conversion from a traditional IRA to a Roth IRA. You also can switch a contribution between IRA categories -- from an after-tax Roth to a tax-deductible or the other way. It's important to follow the IRS recharacterization rules carefully. Depending on your circumstances, a partial recharacterization can get somewhat complicated.
Although a conversion to a Roth IRA must be completed by December 31, the IRS gives you until the day you file your taxes to complete a recharacterization. The normal deadline is April 15 of the calendar year following the tax year, but if you file for an extension, you can push back the recharacterization another six months.
Conversion or Contribution Values
The IRS fixes the value for your IRA conversion on the day the assets were moved to the Roth IRA. Similarly, the value of a contribution to either a Roth IRA or a traditional IRA is pegged to the day it was made.
Calculating Recharacterization Values
When you recharacterize part of the assets from a conversion or contribution, you must adjust the value to match investment performance, and you are not allowed to isolate the individual assets within a conversion, or those specifically resulting from a contribution. The performance factor must be based on the returns of the entire account. For example, assume you converted two securities valued at $5,000 each into a new Roth IRA account. At the time of your recharacterization, the first security has decreased in value to $4,500, while the second one has grown to $6,000. You're not allowed to return the first security to your IRA, and claim a 50 percent or $5,000 recharacterization. The entire account now is valued at $10,500, a 5 percent increase. So, to recharacterize $5,000 of your conversion, you must add 5 percent -- $250 -- for a total of $5,250. You must return all of the first security, and $750 of the second security.
Single Asset Recharacterization
If you made your conversion or contribution into a new account, the recharacterization math will be easier than if the money went into an account holding other assets. But even if the conversion or contribution consisted of a single security, you still must factor in investment performance in your recharacterization. If you received 2 percent in interest at the time of the recharacterization, you'll need to move 51 percent of your investment to claim a 50 percent recharacterization.
If you are making a partial recharacterization from an existing account, your transaction can consist of any assets in the account. For example, assume you bought shares of stock with your contribution to a Roth IRA account that previously held only mutual funds. If you later wanted to make the contribution tax deductible to an IRA account, you can leave the stock in the Roth IRA, and move mutual fund shares in your recharacterization. You will need to factor in the performance of the entire account in figuring how much of the mutual fund to recharacterize.
You must combine all your IRA accounts in figuring the percentage of deductible and after-tax contributions when you make a conversion from a traditional IRA to a Roth. But in a recharacterization, the IRS allows you to base your investment performance solely on the account that received the conversion or contribution. So you may want to consider creating an account expressly to receive that money if you believe you might need to undo the transaction later. That will protect other assets under the same tax status from getting caught up in the recharacterization.
- irs.gov; IRS Publication 590, Individual Retirement Arrangements (IRAs)
- "Tax Guide for Investors"; Recharacterization Blues; Kaye A. Thomas; February 2009
- vanguard:com: Having second thoughts about your Roth IRA conversion?
- "Tax Guide for Investors"; Roth IRA Reconversion to Reduce Taxes; Kaye A. Thomas; January 2008
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