How to Recharacterize Your Roth IRA Conversion…and Why

2010 was the year that anyone — no matter how much they made — could convert a traditional IRA to a Roth IRA. Many investors took advantage of this opportunity in order to enjoy the primary benefit of a Roth IRA — tax-free withdrawals. However, Roth IRA contributions are made with after tax dollars and traditional IRA contributions are made with pre-tax dollars.; therefore, a conversion means that taxes are owed on the amount being converted. Those who took advantage of the 2010 Roth IRA conversion have the option of spreading things out in 2011 and 2012, in order to reduce the immediate burden.

Even with the option to spread the tax bill out, some investors are deciding that perhaps converting to a Roth wasn’t the best option. For those who wish the Roth conversion had never happened, it is possible to recharacterize back to a traditional IRA.

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Who Might Want to Recharacterize

While the transition to a Roth has benefits down the road, there are consequences that take effect right now. Not only do you have to pay taxes, you might also have other complications arising from your conversion. If your account value has dropped since you made the Roth IRA conversion, you may be paying taxes on $12,000, but your account might only be worth $9,000. This makes little financial sense.

Other reasons to consider recharacterization include:

  • Higher AGI: Your Adjusted Gross Income is likely to be increased by your conversion from a traditional IRA to a Roth IRA. For some, it might mean being bumped up a tax bracket for 2010.
  • Reduced eligibility: Your increased AGI might also take you out of the running for certain tax credits. For those looking for student financial aid for themselves or their children might find that the higher resulting AGI can mean ineligibility for certain types of aid.
  • Unexpected expenses: Even if none of the above apply to you, you might have had unexpected expenses that make paying the taxes — even spread out — difficult. You may not want to part with the cash now, since you might need it to cover unexpected costs that have cropped up.

Carefully consider your situation, and your retirement goals, and decide whether or not you really want to keep that Roth conversion. If you decide that you regret the conversion to a Roth IRA, you can recharacterize your account, undoing the conversion.

How to Recharacterize Your Roth IRA Conversion

It is a fairly straightforward process to recharacterize your Roth IRA conversion. You can do it fairly easily, but there is some work involved. The first thing you should do is contact the custodian of your Roth IRA account — this is usually a stock broker or a discount broker. There are forms to fill out when you undo your conversion. You will need the account numbers for your Roth IRA and the traditional IRA. Additionally, you will need the date you made the Roth IRA conversion as well as the amount of any gains seen during the time your account was an IRA.

In some cases, you may want to maintain some of the money in the Roth IRA. This is possible as well. You can recharacterize a portion of your Roth IRA if you don’t want to put it all back as a traditional IRA. Make sure you find out how this is done, and make sure everything has been accomplished as it should be.

Next, you need to file your tax return. If you are recharacterizing, you will need to file a Form 8606. Your account custodian will send you a Form 5498s for each account, so you will have two. You can use these to file your tax return. If you decide to recharacterize after filing your tax return, you will need to file an amended tax return. You will have until October 15 of this year to file your 2010 amended tax return if you want to recharacterize.

About the Author

By , on Jan 4, 2011
Miranda Marquit
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.

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Leave Your Comment (5 Comments)

  1. John Horn says:

    Thanks. I’m not certain either but I do know I have to file an amended return (which I did). I spoke with a CPA and he wasn’t sure but felt that since I had recharacterized within the proper time frame, then there is no additional tax due and “probably” no penalty.

  2. Pinyo says:

    @John – I am not sure what happens in this instance. Normally, you have 2-3 years for the amended tax return, but with the recharacterized IRA…I am not certain. You may want to give the IRS a call (they are very helpful) or consult with a tax professional.

  3. David Qi says:

    The deadline for filing amended tax return is different from file a tax return.

  4. John Horn says:

    OK, I converted a Traditional IRA to a Roth in 2010, then recharacterized the same back to a Traditional IRA in august 2011 (it was a Trustee-to-Trustee transaction). I did not file an amended return for 2010 because I thought a new 8606 for tax year 2011 would cover it. Now it’s 2012 (past the Oct 2011 deadline). What can I do? What if I just file my 2011 returns with a “corrected” 8606?

  5. krantcents says:

    Good information for those who converted their investments to a Roth IRA and needed to go back.

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