5 Most Popular IRA Recharacterization Questions


IRA recharacterization gives investors a chance to undo their IRA conversion, switching between Roth IRA and traditional IRA. Sometimes, investors need to reconsider their decision on traditional IRA or Roth IRA contributions. For example, after converting a traditional IRA to a Roth IRA, you may regret your decision. IRA recharacterization lets you reverse an IRA conversion as if it never happened.

IRA recharacterization can be done in a few simple steps. It is easier if the IRA custodian calculates profit or loss based on the amount you have contributed to a specific IRA account. Otherwise, you have to calculate whether the IRA recharacterization will be profitable on your own. In this post, you will learn some helpful tips for IRA recharacterization.

What is IRA Recharacterization?

Individual retirement account, or IRA, enables business owners as well as their employees save money for their old age. When selecting an IRA account, tax deferred growth or tax free growth funds are the usual options. In case you need to switch, an IRA recharacterization lets you change your contribution from traditional IRA to Roth IRA and vice-versa. Reversing a rollover from traditional IRA to Roth IRA is a more common recharacterization type. In this case, the investor has to request the Roth IRA trustee to transfer the amount in it to the traditional IRA. This transaction can be done within a financial institution and even between two different financial institutions.

Why is IRA Recharacterization Required?

To understand the necessity of IRA recharacterization, you first need to understand the basic characteristics of traditional and Roth IRA. A traditional IRA offers the opportunity to save money without tax deduction. The tax deferred growth increases the volume of your savings. However, when you finally withdraw fund from the traditional IRA, tax gets deducted. In contrast, the Roth IRA lets you save tax deducted money, so that it can grow tax free. Now, after opting for traditional IRA, if you worry about increasing rate of taxes, then you may like to recharacterize it to Roth IRA. By paying the taxes now, you can save money on large tax payments in future.

Why Do People Recharacterize Roth IRA?

Sometimes, investors choose to recharacterize the Roth IRA into a traditional IRA. Many reasons can trigger such a decision. If your Roth IRA asset value has decreased, or the conversion has not happened properly, it is wise to opt for recharacterization. If your taxable income increases, the tax free income from the Roth IRA may actually increasing the overall tax on your income. Furthermore, some individuals convert Roth IRA to a traditional IRA when they do not have money to immediately pay required taxes.

How Can You Recharacterize?

For recharacterizing your IRA contribution or conversion, you will have to move the contribution to the desired IRA account. Financial institutions simply switch the type of IRA to facilitate the recharacterization quicker. Talk to the trustee of the financial institution to find out the exact IRA recharacterization procedure they use and the necessary documentation, if any.

Interestingly enough, instead of converting your traditional IRA contributions to a single Roth IRA, they can be converted into three or more Roth IRA accounts. If you prefer diverse accounts, convert a portion of your traditional IRA contribution to each of the different Roth IRA accounts. By diversifiying, you will be able to monitor when the value of one Roth IRA account is decreasing and recharacterize it. As a result, IRA recharacterization can strategically used to mitigate tax costs.

What is the deadline for IRA Recharacterization?

IRA contributions or Roth conversions must be recharacterized before the tax filing plus extension period is completed. Of course, the tax return has to be filed, generally, before 15th of April. Additionally, you get six months of extension period which gives you until the 15th of October to recharacterize previous year’s IRA account.

As we have determined, IRA recharacterization prevents loss and tax costs to some extent. But, before proceeding, it is necessary to calculate the earnings or savings that the recharacterization will bring about. Accountants or tax assistants can offer strategic help for appropriate utilization of IRA recharacterization.

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