Roth IRA re-characterization to Traditional IRA question

[Bierbrewer]

For quite a few years my wife and I both contributed to our Roth IRAs.  About 5 years ago we started not qualifying for the Roth because our income was too high.  We're right on the edge of not being able to contribute to a Roth every year so I haven't stopped contributing to the Roths, I just been re-characterizing the contributions by October 15th every year to a Traditional IRA.  My question is, I pay the taxes on the income that goes into the Roth but when I have to re-characterize into a Traditional IRA, I don't get any tax break and I can't pull the money out penalty free until 59.5 years old.  Is this right, or am I missing something?  Seems I'm getting the short end of the stick.  Thanks in advance.

[secondcor521]

If your income met the guidelines, you would be able to deduct the amount recharacterized into your traditional IRA because it is treated by the IRS as a contribution to your traditional IRA.  But it sounds like this is not the case.

If your income is too high, the better thing to do (IMHO) is to simply withdraw the Roth IRA contribution before the deadline along with any earnings and contribute it to a taxable account.  That way you still won't get any tax break but you can access the money before 59.5.

Those are the current rules.  If you still feel like you're getting the short end of the stick, lobby your elected officials for change.

[Bierbrewer]

I had no idea that you could just pull the contributions out and put them in a taxable account. I was told by my accountant you had to recharacterize them to a traditional ira. I'm a little disappointed in my accountant now. These funds will be locked up now until 60 years old. I guess chalk it up to a lesson learned.

[Cromacster]

I had no idea that you could just pull the contributions out and put them in a taxable account. I was told by my accountant you had to recharacterize them to a traditional ira. I'm a little disappointed in my accountant now. These funds will be locked up now until 60 years old. I guess chalk it up to a lesson learned.

Or when you quit your job, re characterize to a Roth, wait 5 years, then it's yours!

[Bierbrewer]

Or when you quit your job, re characterize to a Roth, wait 5 years, then it's yours!

Can I recharacterize back to a roth the entire amounts we've put into the traditional ira from the roth in the past 5 years when we quit our jobs?

[secondcor521]

Or when you quit your job, re characterize to a Roth, wait 5 years, then it's yours!

Can I recharacterize back to a roth the entire amounts we've put into the traditional ira from the roth in the past 5 years when we quit our jobs?

First, nothing you do between your traditional and Roth IRAs has anything directly to do with your job.  An indirect link is that there are income limits on some things you can do, and most people's income comes from their job.  A second indirect link will be mentioned below.

Second, moving existing funds within an account from a traditional IRA to a Roth IRA is a conversion, not a recharacterization.  The term recharacterization refers to changing what you want to do with a contribution.  It is important to use the terms correctly because the IRS and your IRA custodian will treat them differently depending on the words you use.

Finally, yes, you can move money from a traditional IRA to a Roth IRA any time your heart desires via a conversion.  If you do so, the amount you convert will be treated as ordinary taxable income and you will have to pay taxes on it.  This is the second indirect link between your job and doing a conversion - if you do the conversion while you are working, you will add that income on top of your job income and it will be taxed fairly heavily.

And you can convert any and all money in your traditional IRA, regardless of whether it came from contributions, earnings, or recharacterizations.

Finally, if you wait 5 years, those conversion amounts can be withdrawn from your Roth tax and penalty free.

Search for Roth pipeline for further details.

[Bierbrewer]

Finally, yes, you can move money from a traditional IRA to a Roth IRA any time your heart desires via a conversion.  If you do so, the amount you convert will be treated as ordinary taxable income and you will have to pay taxes on it.  This is the second indirect link between your job and doing a conversion - if you do the conversion while you are working, you will add that income on top of your job income and it will be taxed fairly heavily.

And you can convert any and all money in your traditional IRA, regardless of whether it came from contributions, earnings, or recharacterizations.

I'm pretty sure I understand the recharcacterization now. Thanks for the help on that.  The rub comes from the fact I paid taxes already on the money that originally went into the roth. Now those funds were moved to a traditional ira and if, or when I move them back to a roth and pull them out, I'll end up paying taxes on them again correct? It appears my screw up will end up costing me double taxation when all I wanted to do was save some taxes somewhere along the line. Hindsight says I should have pulled from the roth and put in a taxable account, not the traditional ira. Am I reading this right?

[secondcor521]

Finally, yes, you can move money from a traditional IRA to a Roth IRA any time your heart desires via a conversion.  If you do so, the amount you convert will be treated as ordinary taxable income and you will have to pay taxes on it.  This is the second indirect link between your job and doing a conversion - if you do the conversion while you are working, you will add that income on top of your job income and it will be taxed fairly heavily.

And you can convert any and all money in your traditional IRA, regardless of whether it came from contributions, earnings, or recharacterizations.

I'm pretty sure I understand the recharcacterization now. Thanks for the help on that.  The rub comes from the fact I paid taxes already on the money that originally went into the roth. Now those funds were moved to a traditional ira and if, or when I move them back to a roth and pull them out, I'll end up paying taxes on them again correct? It appears my screw up will end up costing me double taxation when all I wanted to do was save some taxes somewhere along the line. Hindsight says I should have pulled from the roth and put in a taxable account, not the traditional ira. Am I reading this right?

Correct and yes.  That is what I was trying to say in the second paragraph of my original response.  Non-deductible traditional IRA contributions really are pretty pointless, as you are discovering.  The only benefit is tax sheltering of gains if you happen to realize any inside the IRA.  Live and learn, I guess.

[MDM]

For quite a few years my wife and I both contributed to our Roth IRAs.  About 5 years ago we started not qualifying for the Roth because our income was too high.  We're right on the edge of not being able to contribute to a Roth every year so I haven't stopped contributing to the Roths, I just been re-characterizing the contributions by October 15th every year to a Traditional IRA.  My question is, I pay the taxes on the income that goes into the Roth but when I have to re-characterize into a Traditional IRA, I don't get any tax break and I can't pull the money out penalty free until 59.5 years old.  Is this right, or am I missing something?  Seems I'm getting the short end of the stick.  Thanks in advance.

I got lost in the quoting maze, but are you familiar with the Backdoor Roth IRA?

[Bierbrewer]

Good point on the back door roth.  I am familiar but I rolled over a previous jobs 401k and have a fair amount in there from that.  With the pro-rate rules, it doesn't make much sense for me. 

[MDM]

Good point on the back door roth.  I am familiar but I rolled over a previous jobs 401k and have a fair amount in there from that.  With the pro-rate rules, it doesn't make much sense for me.

Do you have a 401k into which you can roll your tIRA, thus eliminating back door Roth pro-rata concerns?

[PizzaSteve]

Good point on the back door roth.  I am familiar but I rolled over a previous jobs 401k and have a fair amount in there from that.  With the pro-rate rules, it doesn't make much sense for me.

1. Set up a personal 401k with Schwab or Fidelity. 
2.  Roll all traditional IRAs into new personal 401k.
3. Contribute standard annual after tax contribution to the now empty IRA.
4. After a bit of time, convert the after tax contribution to Roth.  If you file taxes properly, this generates no taxes.
5. Viola...Roth contibution even though over the income limit.

This is the Backdoor.