Undoing either a contribution to a Roth IRA or a conversion from a traditional IRA to a Roth IRA is referred to by tax folks as a “recharacterization”. In a recent article about Roth IRA conversions, we said that a conversion from a traditional IRA to a Roth IRA cannot be undone. This has been true for the last few years because of 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 are still allowed to recharacterize a contribution to a Roth IRA. Here are some things to be aware of if you are considering recharacterizing a Roth contribution.
• There is a deadline for recharacterization. The deadline is October 15th of the year following the year of your contribution. If you contributed to a Roth IRA on April 1, 2021, your recharacterization deadline would be October 15, 2022. People who miss the deadline could still recharacterize their contribution if they got a private letter ruling from the IRS, but that is a time consuming and expensive route to take.
• The only way to execute a recharacterization is by means of a trustee-to-trustee transfer. You are not allowed to do so by a 60-day rollover.
• Be aware of 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) that are attributable to the recharacterized amount. Being aware of this difference is helpful when you fill out your federal income tax return for the year of the recharacterization.
• Be aware of any specific policies your IRA custodian might have and restrictions it might impose. While the Internal Revenue Code allows you to recharacterize all or just a portion of your contribution, the custodian’s policies may not be as flexible. You might also find restrictive policies if your Roth is invested in annuities or other contractual investments. Another custodial policy that might interfere is a requirement to maintain a specific minimum balance in your account.
• Understand that you might have to file an amended return in order to get back taxes that you paid at the time of the contribution. This would be the case if you recharacterize the contribution after you’ve filed your tax return for the year in which the contribution took place.
All of this information, and more, can be found in the IRS Publications that deal with IRAs. Before tax laws reached their current level of complexity, there was only one publication that dealt with IRAs, now there are two: 1) Publication 590-A, Contributions to Individual Retirement Arrangements; and 2) Publication 590-B, Distributions from Individual Retirement Arrangements. If you check the IRS publications on their website, you cam be sure that you are getting the most up-to-date information.
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