Author Topic: How does Recharacterization of IRAs work?  (Read 1832 times)

climber1

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How does Recharacterization of IRAs work?
« on: March 28, 2015, 11:38:08 PM »
I expect my income in 2015 to be above both the limit to contribute to a Roth IRA and to take a deduction for a Traditional IRA contribution. So I want to do a backdoor Roth. It would be great to do so now in order to get the money in the market (I have too much in my savings account). However, what if something unexpected changes later in the year (for example, I lose my job), I would prefer to have contributed directly to a Roth or to have kept it in the Traditional IRA? Would it be possible to fully reverse this?

It looks like it would be possible to do a recharacterization to reverse the conversion to a Roth. And then once I have done that, it is possible to reverse the Traditional IRA contribution at any point before April 15 of the next year with penalty. That would give me back the cash which I could put into the Roth IRA directly if I wanted to. It seems like this is all possible without penalty. Does anyone see any problems?

MDM

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Re: How does Recharacterization of IRAs work?
« Reply #1 on: March 28, 2015, 11:45:02 PM »
So I want to do a backdoor Roth.  However, ... if something unexpected changes..., I would prefer to have contributed directly to a Roth....
Why, if you have already put the money into the Roth via the back door, would you want to take it out and redeposit it through the front door?

climber1

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Re: How does Recharacterization of IRAs work?
« Reply #2 on: March 28, 2015, 11:58:31 PM »
Yeah, guess I should have explained that. My understanding of the rules surrounding withdrawals is that they are more favorable if I would make the contribution directly.

So, if I contribute $5500 directly to my Roth IRA, I can withdraw that $5500 whenever I want (though not the earnings). If I instead put it into a Traditional IRA and then rollover, I could potentially have to pay the 10% additional tax on this amount. Specifically, according to Publication 590,
Quote
Distributions of conversion and certain rollover contributions within 5-year period.   If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan to a Roth IRA, you take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the amount converted or rolled over (the conversion or rollover contribution) that you had to include in income (recapture amount).

Now, if my income stays sufficiently high that my traditional IRA is nondeductible, then this doesn't matter as the recapture amount is zero (since this money wasn't taxable because of the rollover since it was already taxed). On the other hand, if my income is lower than expected, the full $5500 would be included in the recapture amount and I would have to pay the 10% tax on it if I wanted to withdraw this money within 5 years.

MDM

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Re: How does Recharacterization of IRAs work?
« Reply #3 on: March 29, 2015, 12:32:59 AM »
My understanding of the rules surrounding withdrawals is that they are more favorable if I would make the contribution directly.
Yes.  Wanted to ensure you understood some details and it appears you do.

As for "recharacterization to reverse the conversion" - I'll defer to others who may have done this.  Good luck - primarily, that you keep your job and this all becomes moot.

climber1

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Re: How does Recharacterization of IRAs work?
« Reply #4 on: March 29, 2015, 12:43:12 AM »
Good luck - primarily, that you keep your job and this all becomes moot.

Don't worry, I don't expect to lose my job as I am rather good at it (and making the company a LOT more money than they are paying me). It wa just a quick explanation of why my income could change suddenly. The more likely scenario for me needing to do this is that in some future year, I decide to leave (to take a sabatical, found a startup, etc.). But better to acquire the knowledge now to understand the full consequences of my financial decisions.