Time Limits For Recharacterizing An IRA
In 2010, the IRS lifted the Adjusted Gross Income limitation on traditional to Roth IRA conversions, prompting many people to transfer their traditional IRA savings to Roth accounts. If you were one of these people and later changed your mind, or if you have contributed to a Roth IRA, only to find your income was greater than the allowable AGI limit for the year, you may wish to recharacterize your IRA contribution to correct the issue.
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SIgnificance
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Recharacterization offers a "do-over" -- an opportunity to correct a mistake, while still retaining tax-preferred retirement savings. While the term is occasionally used for traditional to Roth IRA conversions, the IRS considers a recharacterization to be the reversal, a reversion of Roth IRA contributions to traditional IRA status.
Most often, recharacterization is used in the case of error: you convert your traditional IRA to a Roth only to discover you do not have enough money to pay the conversion tax. You contribute to a Roth IRA, but your AGI goes over the annual limit ($105,000 for single filers in 2010). You have two types of IRA, and your contribution is deposited to the wrong one.
Recharacterization is also used to offset a large loss in a newly converted Roth IRA. If you move your money, owe tax on that amount and then suffer a significant loss, you can undo the conversion and avoid paying more tax than necessary.
Time Frame
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Recharacterizations must be completed no later than the tax filing deadline of the related year, April 15 for most people, or October 15 if you file for an extension. You cannot recharacterize for a prior year; this must be treated as an excess contribution. For tax purposes, the full amount of a traditional-to-Roth conversion is considered a contribution.
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Procedure
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To recharacterize a contribution, you must withdraw the full amount of the contribution from your Roth IRA and re-deposit that value to a traditional IRA along with any earnings. If you are recharacterizing the entire account, you may be able to change the account type with your IRA custodian rather than perform a complete trustee-to-trustee transfer.
Any withdrawal must include earnings or losses. Calculate the earnings by dividing the net change in account value (value at correction minus value before the contribution, adjusted for additional contributions or conversions) by the account value at correction. Take this percentage and multiply it by the value of your contribution to determine the total earnings. Your IRA custodian can assist you in calculating the number.
Considerations
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It is important to note that IRA contributions made in error may be withdrawn without a penalty if the correction is made prior to the tax filing deadline. In some cases this may be preferable to a recharacterization. Your financial adviser can help determine the best course of action for your situation.
Warning
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Excess contributions or failed conversions result in penalties if not corrected promptly. Take action as soon as you recognize an error to avoid these additional taxes.
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