Undoing a Conversion (Recharacterization)
Transfers & Rollovers
What is a Roth IRA conversion?
A Roth IRA conversion is a type of transaction in which you elect to move or convert some or all of your Traditional IRA savings to a Roth IRA.
What are the tax consequences of a Roth IRA conversion?
The amount you convert to a Roth IRA is typically taxed as ordinary income in the year of conversion (except for amounts representing basis in your existing plan). If you are under age 59½, the 10 percent early distribution penalty tax does not apply to the amount you convert
, however, additional distributions taken to pay conversion taxes may be subject to the 10 percent early distribution penalty unless you qualify for a penalty exception.
How can a Roth IRA conversion help protect me from future tax rate increases?
When you convert retirement savings to a Roth IRA, you pay taxes in the year of conversion based on the current federal income tax rates. Once converted to a Roth IRA, future earnings generally accrue on a tax-free basis thereby providing protection from future tax rate increases.
Do tax rates have to go up significantly for me to benefit from a Roth IRA conversion?
No. While the potential benefits of a Roth IRA conversion vary significantly depending on each individual’s circumstances, in many cases a Roth IRA conversion can yield significant benefits even without anticipating a significant increase in future tax rates. This is especially true if you have non-IRA resources available for paying the taxes on a Roth IRA conversion.
Is there any benefit of a Roth IRA conversion if tax rates stay the same (or actually go down) in the future?
While one of the key advantages of a Roth IRA conversion is its ability to help you hedge against future tax increases, this is not the only potential benefit of a Roth IRA conversion. For example, unlike Traditional IRA savings, Roth IRA savings are not subject to mandatory distributions beginning at age 70½ and, therefore, can provide valuable extended tax shelter if you are hoping to pass some or all or your retirement savings on to your heirs.
How can a Roth IRA conversion potentially help me provide a greater financial legacy to my heirs?
When you convert retirement savings to a Roth IRA, you pay taxes in the year of conversion based on the current federal income tax rates. Once converted to a Roth IRA, future earnings generally accrue on a tax-free basis (versus a tax-deferred basis as with Traditional IRA savings).
What’s more, unlike Traditional IRA savings, Roth IRA savings are not subject to mandatory distributions at age 70½. Because Roth IRA assets are not subject to mandatory distributions during your lifetime, the Roth IRA allows you to extend the tax-sheltered life of your retirement savings which can potentially result in a greater financial legacy for your heirs that is likely tax-free.
Is there an income restriction as to who is eligible to convert a Traditional IRA to a Roth IRA?
No. There are currently no income restrictions as it applies to Roth conversion eligibility.
Prior to 2010, individuals or couples with modified adjusted gross income (MAGI) in
excess of $100,000 (as well as married individuals who filed separately) were ineligible to convert
retirement savings to a Roth IRA. The Tax Increase Prevention and Reconciliation Act (TIPRA),
enacted on May 17, 2006, removed the eligibility restrictions for Roth IRA conversions, effective
January 1, 2010. As a result of TIPRA, anyone with eligible
retirement plan (including Traditional IRA) assets is able to convert to a Roth IRA regardless of income.
Am I eligible to convert my Traditional IRA assets to a Roth IRA?
Yes, virtually all individuals with eligible retirement plan (including Traditional IRA)
assets who are willing to pay conversion taxes are eligible to convert assets to a Roth IRA.
Which of my assets are eligible for conversion to a Roth IRA?
Traditional IRA assets, including contributions made to your Traditional IRAs under simplified employee pension (SEP) plans, may be converted to a Roth IRA. SIMPLE IRA assets may also be converted to a Roth IRA as long as it has been at least two years since you first received a SIMPLE IRA contribution under the employer’s SIMPLE IRA plan.
In addition, eligible distributions from qualifying employer retirement plans may be rolled over (which is very much like a conversion) to your Roth IRA. Qualifying employer retirement plans include qualified plans (e.g., 401(k) plans or profit sharing plans), governmental 457(b) plans, 403(b) arrangements, and 403(a) arrangements.
May I convert my required minimum distribution (RMD) from my existing plan to a Roth IRA?
No, required minimum distributions (RMDs) may not be converted. However, once your required minimum distribution is withdrawn, you may generally convert all or a portion of the remaining plan balance.
May I convert nondeductible Traditional IRA assets to a Roth IRA?
Yes. Basis, including nondeductible Traditional IRA contributions, may be converted to a Roth IRA. When you convert, tax is not paid on the portion of the conversion that represents the return of basis. However, it is important to note that is it not possible for you to convert Traditional IRA basis only. If you convert only a portion of your IRA, the conversion is pro rata representing a portion of the assets subject to taxation and a portion that represents the return of basis. For purposes of calculating the return of basis, you must treat all of your Traditional and SIMPLE IRAs as one IRA.
If you have nondeductible basis in any of your IRAs and you elect to conduct a full or partial Roth IRA conversion, you must complete IRS Form 8606, Nondeductible IRAs, to calculate and claim as nontaxable the portion of the Roth IRA conversion that represents nondeductible basis.
May I convert to a Roth IRA even if I do not have earned income?
Yes. You do not have to have earned income to be eligible to convert existing retirement plan savings to a Roth IRA.
I am in the middle of a series of substantially equal periodic payments (i.e., 72(t) payments); may I still convert my Traditional IRA?
Yes. Converting a Traditional (or SIMPLE) IRA from which you are currently receiving substantially equal periodic payments is not considered a modification of the payment schedule. Once converted, you must continue the payments from the Roth IRA as scheduled. If the series of payments does not continue, the series of payments will have been modified and the retroactive penalty will apply.
I have after-tax basis in my Traditional IRA; may I convert just the after-tax amounts?
No. It is not possible for you to convert only Traditional IRA basis. If only a portion of your IRA is converted, the conversion is pro rata representing a portion of the assets subject to taxation and a portion that represents the return of basis. For purposes of calculating the return of basis, you must treat all of your Traditional and SIMPLE IRAs as one IRA.
I inherited a Traditional IRA from my aunt, can I convert the Inherited Traditional IRA to an Inherited Roth IRA?
No. As a nonspouse beneficiary, you are not eligible to convert an Inherited Traditional
IRA to an Inherited Roth IRA. However, nonspouse beneficiary(ies) that inherit an
eligible retirement plan (i.e. qualified plans (e.g., 401(k) plans or profit sharing plans),
governmental 457(b) plans, 403(b) arrangements, and 403(a) arrangements) other than
a Traditional IRA, may rollover (convert) those assets to a Roth IRA through a direct
trustee-to- trustee transaction from the distributing plan to the Inherited Roth IRA
without the nonspouse beneficiary having constructive receipt of the assets.
May I convert my Traditional IRA to my existing Roth IRA, or do I have to establish a new Roth IRA to receive the conversion contribution?
Usually, you may convert your Traditional IRA to your existing Roth IRA. However, if you prefer, a new Roth IRA may be established to receive the conversion contribution. Just to be safe, it is best to check with your Roth IRA custodian/trustee for any policies specific to the Roth IRAs held by the custodian/trustee. Also, certain conversion strategies dictate whether you should convert to an existing or to a newly established Roth IRA. Check with your financial advisor to determine conversion strategies appropriate for you.
What is the deadline for a Roth IRA conversion?
How do I convert (roll over) my 401(k) plan assets to a Roth IRA?
Conversions are taxable (includable in gross income) in the tax year of the distribution
from the Traditional IRA, SIMPLE IRA or eligible retirement plan. If you want the
distribution to be taxable in 2015, the distribution that is subsequently converted must
be withdrawn on or before December 31, 2015. However, be sure to check with your IRA
custodian/trustee or plan administrator to see if earlier deadlines apply. Many IRA
custodians/trustees and plan administrators set earlier deadlines so that there is adequate
time to process conversions by year end.
Assets from your 401(k) plan or any other qualifying employer retirement plan (e.g., profit
sharing plans, governmental 457(b) plans, 403(b) arrangements, and 403(a) arrangements)
may be converted (rolled over) to a Roth IRA either directly or indirectly.
To complete a direct conversion (rollover), you instruct the plan administrator of your 401(k) plan to send the distribution to your Roth IRA custodian/trustee.
To complete an indirect conversion, you request the plan administrator to distribute your
plan balance to you. You then have 60 days from the date you receive the distribution
to complete the transaction. When you receive a distribution, the plan administrator
is generally required to withhold 20 percent of the eligible rollover distribution for
federal income tax withholding purposes. If you chose the indirect rollover method
to complete your Roth conversion (rollover), you may, however, make-up the 20 percent withheld
amount out-of-pocket and convert the full amount.
Note: While an employer plan to Roth IRA transaction is commonly referred to as a
conversion (as it is here in this FAQ) because the transaction resembles a conversion from
a tax perspective, the employer plan to Roth IRA transaction is technically a rollover
and reported as such by your IRA trustee/custodian.
Is there a limit to the number of Roth IRA conversions that I can do within a 12-month period or some other period of time?
There is no limit to the number of Roth IRA conversions that can be done.
Is it possible to convert my existing Traditional IRAs and retirement plans to a Roth IRA over several years?
Yes, you may convert all or a portion of your Traditional IRAs and retirement plans at
any time. Any amount that is converted to a Roth IRA is includable in gross income
for the taxable year in which the amount is distributed from the Traditional IRA, SIMPLE
IRA or eligible retirement plan. By converting a portion of your existing retirement
assets over several years, you will spread the tax liability over a number of years.
I have a variety of stocks and mutual funds in my Traditional IRA. Do I have to liquidate these assets prior to converting to a Roth IRA?
No. As long as the Roth IRA custodian/trustee is able to hold the type of assets you have in your Traditional IRA, there is no need to liquidate your Traditional IRA investments when converting to a Roth IRA.
When I convert to a Roth IRA, does the 10 percent early distribution penalty tax apply to the amount that I have withheld for federal income taxes?
Potentially, yes. While the 10 percent early distribution penalty tax does not apply to the assets that are converted to a Roth IRA, the early distribution penalty does
apply to other distributions (including amounts withheld for federal income taxes) if you are not yet age 59½ and do not meet another penalty exception.
Federal income tax was withheld from my retirement plan distribution. What happens if I don’t convert the amount withheld for taxes?
Just like any other retirement plan distribution, amounts withheld for federal income taxes are generally includable in gross income, and are, therefore, taxed. In addition, if you are not yet age 59½ or older, and do not meet another early distribution penalty exception, the amount withheld for federal income taxes is generally subject to a 10 percent early distribution penalty.
If, within 60 days of distribution, you “make-up” the withholding out-of-pocket and deposit an amount equal to the tax withholding as a conversion contribution, you would avoid the 10 percent early distribution penalty.
Are federal income taxes withheld on a Traditional/SIMPLE IRA or retirement plan distribution that is subsequently converted?
There are no special withholding rules for IRA/plan distributions that are subsequently directly or indirectly converted to Roth IRAs. Before making any decisions on income tax withholding consult your tax advisor.
For IRAs, the distributing custodian/trustee must furnish you with a withholding notice which notifies you of your right to waive withholding. You may waive out of withholding or elect to have 10 percent or more withheld from your distribution. If you do not opt out of withholding or do not elect to have 10 percent or more withheld, the custodian/trustee must generally withhold 10 percent of the IRA distribution. Note: Special withholding rules apply to certain IRAs that have been annuitized.
For other eligible retirement plans, the withholding rules depend on whether the conversion is handled indirectly or directly. Eligible rollover distributions (that may ultimately be part of an indirect conversion) paid to you or your spouse, are subject to 20 percent mandatory withholding. Whereas distributions that are directly converted from the plan to a Roth IRA are not subject to mandatory withholding, even though you and the plan administrator are permitted to enter into a voluntary withholding agreement.
What does it mean to recharacterize a Roth IRA conversion?
Under federal law, taxpayers have the option of “undoing” a Roth IRA conversion transaction by doing a recharacterization. When you recharacterize a Roth IRA conversion transaction, you’re essentially electing to put things back to the way they were prior to the conversion. However, if your entire Roth IRA balance is not being moved to the Traditional IRA as part of the recharacterization, consult your tax advisor prior to recharacterizing for possible ramifications of your recharacterization.
How do I recharacterize a conversion?
You must initiate the recharacterization with your Roth IRA custodian/trustee by making an irrevocable election to recharacterize. The conversion amount that you recharacterize along with any gain or loss attributable to that amount will be directly transferred to your Traditional IRA.
What are the tax consequences of recharacterizing a conversion?
There are no tax or penalty implications associated with recharacterization itself. For tax purposes, when you recharacterize a conversion contribution the amount recharacterized is treated as if it had never been converted. However, if your entire Roth IRA balance is not being moved to the Traditional IRA as part of the recharacterization, consult your tax advisor prior to recharacterizing for possible ramifications of your recharacterization.
What is the deadline for recharacterizing a conversion?
The deadline for completing a recharacterization is your tax return due date (including any extensions) for the year of the Roth IRA conversion. However, if you filed your federal income taxes timely, you have up to six months after your income tax filing deadline to recharacterize. For example, if you converted to a Roth IRA in 2014 and filed your 2014 federal income tax return on time, you have until October 15, 2015 to recharacterize your 2014 conversion.
Can I recharacterize a portion of my conversion contribution?
Yes. All or a portion of a conversion contribution may be recharacterized. However, it is important to recognize that the net income (or loss) attributable to the recharacterized amount that must accompany the recharacterized portion is calculated as a pro rata portion of the aggregate income earned on the entire Roth IRA during the period the IRA held the contribution. For more information on partial recharacterizations, see the next question
Last year, I converted all of the assets in my Traditional IRA in-kind to a Roth IRA. Because the value of one of my investments has dropped significantly since the conversion, I would like to recharacterize just those shares. Is this possible?
Although you may
choose which assets go back to the Traditional IRA as part
of a recharacterization, doing so will probably not achieve your objective. When
the entire Roth IRA is not being transferred back to the Traditional IRA as part of the
recharacterization and there is more than one investment in the Roth IRA, the net income
(loss) attributable (NIA) to the conversion amount being recharacterized must be allocated
pro ratably to each investment. In other words, the NIA is based on the overall dollar
amounts contributed, distributed and/or recharacterized. Dollars or assets in-kind are
contributed to an IRA and the investments generate gains or losses. Once contributions
are commingled in an account, these dollars are no longer associated with particular assets.
Example: On January 3, 2014, Susan converts 500 shares of ABC stock
valued at $100,000 and 200 shares of XYZ stock valued at $100,000 from her Traditional
IRA to a Roth IRA. No distributions or additional contributions have been made to
this Roth IRA at any time. On March 22, 2015, the value of Susan’s Roth IRA has
increased to $220,000 (500 shares of ABC stock valued at $70,000 and 200 shares of XYZ stock
valued at $150,000). In this scenario, if Susan chooses to move the underperforming
ABC stock (500 shares), now valued at $70,000, back to the Traditional IRA as a
recharacterization, she is recharacterizing only $70,000 of the original conversion leaving
a net conversion of $130,000. In addition, Susan must also transfer an additional $7,000
NIA, forcing her to move $7,000 worth of her XYZ stock. As a result, Susan will be forced
to include $130,000 in income as part of the net conversion, with something less than the
200 shares of XYZ stock remaining in the Roth IRA.
What is a failed conversion?
An ineligible conversion becomes a failed conversion if you do not correct it timely with a recharacterization. Failed conversions are considered to be annual Roth IRA contributions for the tax year of the conversion. If the amount exceeds your allowable contribution limit, it is then treated as an excess Roth IRA contribution.
Is there a remedy available for correcting my failed conversion?
Is there any special tax reporting associated with a recharacterization?
Yes. Recharacterizations are reported by both the Traditional and Roth IRA custodian(s)/trustee(s). In addition, you must generally report recharacterizations to the IRS by attaching a statement to your Form 1040. You may also need to file Form 8606, Nondeductible IRAs
, with your income taxes. For assistance with recharacterizations, refer to IRS Publication 590 and/or your tax advisor.
Can I reconvert assets that I have previously converted and recharacterized?
Yes. You may reconvert assets that have been previously converted and recharacterized. However, a reconversion must occur in a subsequent year to the prior conversion, or if later, after 30 days have elapsed since the recharacterization.
Are the time restrictions for reconversion tied to the assets or the IRA?
If you elect to recharacterize all or part of a rollover or conversion to a Roth IRA, you cannot reconvert the amount recharacterized to the same or another Roth IRA until the later of:
- 30 days after the recharacterization, or
- the year following the year of the rollover or conversion.
However, this waiting period does not apply to amounts other than the ones recharacterized, including additional amounts from that same Traditional IRA (or employer plan) or amounts from a different Traditional IRA (or employer plan).
What options do I have if I change my mind after completing a Roth IRA conversion?
If you change your mind after completing a Roth IRA conversion, within a limited period of time, you may elect to “recharacterize” all or a portion of an amount that you converted. When you elect to recharacterize, you redeposit the converted assets into a Traditional IRA and, if the entire conversion amount is recharacterized, it will nullify any of the tax consequences of the initial conversion transaction. However, if your entire Roth IRA balance is not being moved to the Traditional IRA as part of the recharacterization, consult your tax advisor prior to recharacterizing for possible ramifications of your recharacterization.
Can a pre-tax amount rolled over from a 401(k) or another employer retirement plan to a Roth IRA be recharacterized?
Yes. Amounts rolled over from an employer retirement plan to a Roth IRA may be recharacterized by transferring the recharacterized amount plus the net income/loss attributable to a new or existing Traditional IRA, and not back into the plan from which they were distributed.