Tuesday, October 11, 2011

Roth Recharacterization Deadline Final Word

There is one final word to add on the Roth recharacterization deadline for Roth IRA conversions completed in 2010. The recharacterization deadline for residents residing in certain counties of states impacted by Hurricanes/Tropical Storms Irene and Lee, as well as the Texas wildfires, has been extended to October 31, 2011. Details regarding this relief can be found on the IRS website at the following location:


Given the financial importance of the recharacterization topic to many of our readers, we want to summarize for the very last time (this year) the reasons to consider one.

The first reason is the most obvious: Asset value decline.

For example, if you converted to a Roth IRA in 2010 and the market value of the conversion was $100,000 you will pay income tax on any part of that amount that does not consist of after-tax funds. You either opted to pay the tax in full in 2010 or you could spread the conversion amount equally over 2011 and 2012.

Let’s assume that the market value declined and the value of the conversion is now $60,000. By October 17, 2011 you can undo (recharacterize) the conversion, recoup any taxes you've already paid or avoid paying any remaining tax on the $100,000. The recharacterization must be done as a trustee-to-trustee transfer, rather than as a withdrawal from the Roth IRA and a subsequent deposit to a traditional IRA.

The rules regarding the re-conversion of recharacterized funds require you to wait until more than 30 days have passed since the recharacterization, or until January 1 of the year following the year of the original conversion, whichever is later. In this case, the 30-day waiting period would apply.

The second reason for recharacterizing is that you do not enough ready-cash available to pay the income tax due on the conversion. It is always better to pay any conversion-related taxes using funds from outside of a retirement plan.

The third reason is that you have slid into a lower tax bracket, perhaps due to some unexpected business losses, and it makes no sense to pay the conversion tax at a rate higher than the one you currently occupy.

Fourth, perhaps you’re not maximizing the long-term impact of your IRA contribution. While there is no more income limit associated with conversions (so everyone with an eligible account can convert it to a Roth IRA if they so desire), income limits do still exist with respect to your ability to make annual Roth IRA contributions and to deduct traditional IRA contributions. So, if you find that you have contributed more than you can deduct to a traditional IRA, see if you qualify for a Roth IRA and then recharacterize your contribution.

If you want in-depth articles on these reasons and anything else associated with Roth recharacterizations, visit this LINK for a complete list of articles from our Roth Recharacterization Week.

By Marvin Rotenberg and Jared Trexler
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*Copyright 2011 Ed Slott and Company, LLC


John Weber said...

I have a general question not to do with recharacterization.

The IRS limits contributions to an IRA, "If you are covered by a retirement plan at work".

What if a person has a plan at his work, but is not enrolled; or is enrolled but no longer contributing; or does not contribute himself, but gets free contributions from his employer?

In short, what is the definition of the word, "covered"?

Thank you,
John Weber

Jared Trexler said...


You can always make an IRA contribution, even if you have a plan at work, you just might not be able to deduct it. You can be considered to be covered by a plan even when you are not contributing to the plan. The employer is required to notify IRS if you are covered by checking a box on your W2 that you receive each year.

Best Regards,

Beverly DeVeny
The Slott Report Staff