IRA

Roth IRA Recharacterization - Is It or Is It Not an Option?

February 2, 2018
By: Chin Kim

Do your clients want to know if a Roth IRA conversion that took place in 2017 can still be recharacterized back to a traditional IRA before the tax due date in 2018?

Reading the Conference Committee's report about the details on changes to Roth IRA recharacterizations could lead to one question: If a Roth IRA conversion took place in 2017, can it still be recharacterized back to an IRA before the tax due date in 2018?

Just as our eyes can be tricked by the Müller-Lyer optical illusion as to which line is longer, many felt the same confusion when reading the statement in the Conference Committee's report discussing the elimination of the ability to unwind a Roth IRA conversion as a result of the new Tax Cuts and Jobs Act (TCJA).

"Thus, recharacterization cannot be used to unwind a Roth conversion.
Effective Date: The provision is effective for taxable years beginning after December 31, 2017."
Source: Joint Explanatory Statement of the Committee of Conference, pages 115–116.

The statement above could be interpreted as either:

  • This will apply only to Roth IRA conversions that take place after 2017.
  • This also will apply to Roth IRA conversions that took place in 2017, but if your client chooses to recharacterize, the recharacterization must have taken place by the end of 2017.

Luckily, the IRS recently posted several FAQs to address this confusion.  The FAQs clarify the situation by stating the following:

How does the effective date apply to a Roth IRA conversion made in 2017?

A Roth IRA conversion made in 2017 may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018. A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized. For details, see "Recharacterizations" in Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).

Nevertheless, with gains in the equity market up double digits during 2017, unless someone has difficulties paying the conversion taxes, I wonder why a person would decide to recharacterize a 2017 Roth IRA conversion.
 

Example: Tax Savings as a Motive to Recharacterize Before 2018

Individuals usually will consider recharacterization of their Roth IRA conversions should their Roth IRAs decline in value from the original conversion amount.  If someone converts a Roth IRA valued at $100,000 on 12/31/17, the person will owe tax on $100,000. If the value of the Roth IRA drops to $50,000 in 2018, he or she would be better off recharacterizing to avoid paying taxes on $100,000 when the account is now worth only $50,000. He or she could then reconvert and pay tax on $50,000 in the future. It’s the growth on the Roth IRA that’s tax-free, which means getting in before the assets appreciate is the real planning opportunity.

 

Will Not Sunset

Unlike other TCJA changes relating to individual taxpayers (e.g., income-tax rates), the option to recharacterize is not coming back after 2025.

I am certain there will be other ambiguous items that we uncover in the TCJA.  The Retirement Strategies Group is here to support you concerning questions you have about the recent changes and matters related to retirement planning.

 

We also are curious to hear what you are seeing and hearing from your clients so we can consider these items for future topics.  Please feel free to contact us at (800) 722-2333, extension 3939, or email us at RSG@PacificlLife.com.

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Chin Kim leads the Retirement Strategies Group, as Assistant Vice President in the Retirement Solutions Division at Pacific Life. His core responsibilities includes sharing and supporting retirement strategies concepts through development of marketing materials and tools and leading the team members in the field and in the home office.

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