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Tutorial: Roth IRA Recharacterizations

A recharacterization is either a reversal of a Roth IRA conversion or changing a contribution from a Roth IRA to a traditional IRA or from a traditional IRA to a Roth IRA. A recharacterization is usually done for reasons which include the following:

Recharacterizations of Contributions
o   The individual made the contribution to a Roth IRA and it is determined that he is ineligible for the Roth IRA contribution
o   An individual made a contribution to a traditional IRA and is ineligible to claim the deduction, but is eligible for a Roth IRA contribution
o   The individual decides that it makes better financial sense to fund the other type of IRA, instead of the one that was initially funded with the contribution
o   An individual who made a regular contributions to one type of IRA (Roth IRA or traditional IRA), and wants to change the type of IRA to which the contribution was made, for personal, eligibility or tax reasons.
Recharacterizations of Roth IRA Conversions
o   The Roth IRA owner is ineligible for the conversion
o   The conversion is a reconversion that was done before the amount was eligible to be reconverted. See Tutorial: Roth IRA Reconversions  for an explanation of the reconversion rules
o   The value of the assets has fallen much lower than they were at the time the conversion occurred.
o   The individual decides that it makes better financial sense to keep the assets in a traditional IRA
o   The individual is unable to pay the tax that would be due on the conversion
Deadline for Completing a Recharacterization  
Recharacterizations must be completed by the IRA owner’s tax filing deadline, including extensions. Individuals who file their tax return on time or file for an extension by the due date of their tax return, receive an automatic six-month extension. For individuals who file on a calendar year, the six-month extension ends on October 15. For instance, if the excess contribution occurred last year, the extension would end on October 15 of this year.
How to Recharacterize a Contribution or Roth Conversion
When an IRA contribution or a Roth IRA conversion is recharacterized, it must be accompanied by any net income attributable (NIA) to the excess.
If the only credit to the Roth IRA is the excess contribution or the Roth conversion that is being recharacterized, recharacterizing the entire balance is sufficient.
If only a portion of the contribution or Roth conversion is being recharacterized, or if the account has balances attributed to other credits, such as other Roth conversions, transfers, or other contributions, the IRS provided formula must be used to determine the NIA. The following is the formula used to compute the NIA:

NIA
=
Contribution or conversion
[ adjusted closing balance
-
Adjusted opening balance]
 
Adjusted opening balance

           
Let’s look at an example to illustrate how the formula works.
John made a conversion of $10,000 to his Roth IRA on July 1, at which time his Roth IRA was worth $50,000. John no longer wants to pay the tax on the conversion and decides to recharacterize the amount by the deadline. He had previously made other contributions, conversions and transfers to the same Roth IRA. John submits a request to his Roth IRA custodian to remove the excess from his Roth IRA; at that time, the Roth IRA is valued at $65,000. No other activity occurred during the computation period [1].
The NIA is computed as follows:
 

NIA
=
Conversion amount
X
-
 
 
NIA
=
$10,000
X
[ $65,000
-
$60,000]
 
 
$60,000
NIA
=
$10,000
X
[ $65,000
-
$60,000]
 
 
$60,000
NIA
=
$10,000
X
-$5,000
 
 
$60,000
NIA
=
$10,000
X
-0.08
$833.33

 
Since the NIA is $888.33, the amount that must be recharacterized from John’s Roth IRA to is $10,888.33 (excess + the NIA).
When NIA is a Loss
If the NIA had been a loss, John would reduce the $10,000 by the loss, and recharacterize the net amount.


[1] The period beginning immediately prior to the time that the contribution that is being returned was made to the IRA and ending immediately prior to the removal of the contribution.
 
  
                    I.            Tutorial: Roth IRA Contributions
                  II.            Tutorial: Excess Roth IRA Contributions
                III.            Tutorial: Roth IRA Conversions
               IV.            Tutorial: Roth IRA Reconversions
                 V.            Tutorial: Roth IRA Rollovers and Transfers