By Kaye A. Thomas
Current as of February 10, 2018
A closer look at the rules for recharacterizations.
Some types of contributions are eligible for this treatment, and others are not.
- Yes: regular contributions to traditional or Roth IRAs. If you make a regular contribution to a traditional IRA and want it to go instead to a Roth IRA — or vice versa — this rule allows you to pull the switch.
- Yes: conversion contributions before 2018. When you convert a traditional IRA to a Roth IRA, you’re actually making a contribution to your new Roth IRA. For pre-2018 conversions, you’re allowed to redirect that contribution to a traditional IRA under this rule, in effect undoing the conversion.
- No: post-2017 conversions.The 2017 tax law disallows recharacterizations for these conversions.
- No: tax-free rollovers. If you made a tax-free rollover to a traditional IRA, you can’t transform that event into a conversion to a Roth IRA. It doesn’t matter whether the rollover came from an employer plan or another IRA. You can’t change a tax-free rollover into a Roth IRA conversion.
- No: employer contributions. You can’t use this rule to switch an employer contribution from a SEP IRA or SIMPLE IRA into a Roth IRA. That includes salary reduction contributions, because those contributions are considered to be made by your employer, even though you made the choice for the money to go into the plan. If you made your own contribution to a SEP IRA (the kind of contribution that’s subject to the regular IRA contribution limits), you should be able to redirect that money to a Roth IRA, though, because that’s not an employer contribution.
When to act
If you plan to use this rule, the deadline for action is the due date of your tax return for the year of the original contribution, including extensions. (If you follow a special procedure, you can obtain an extended due date even if you filed your tax return without an extension.) The year of the original contribution means the year to which it relates, not the year the contribution was actually made.
- If you make a regular contribution before April 15, 2018 and designate it as a 2017 contribution, your deadline for making the change is the due date of your 2017 return (with extensions), even though you made the contribution in 2018.
- If you withdrew money from your traditional IRA in 2018 and completed a conversion to a Roth IRA in 2018 (within 60 days of the withdrawal) you’ve made a 2017 conversion. Once again, this means the deadline for recharacterizing the transaction is the extended due date of your 2017 return.
Alert: It isn’t enough for you to take action within this time limit. Your trustee has to complete the transfer before the deadline. It’s best to take action well in advance so there’s time to follow up and confirm that the trustee finished the paperwork.
The earnings rule
You can’t switch your contribution unless you also switch the earnings on the contribution. For example, if you started a Roth IRA with $2,000 in January, but decided at the end of the year you’d rather have the deduction from a contribution to a traditional IRA, you have to move the $2,000 and the earnings on the $2,000 to have a good switch.
If there’s a loss instead of earnings, you simply switch the amount that’s left from the original contribution. You don’t have to make up for the loss with an added contribution. In fact, you’re not permitted to do that.
Most people who make a switch will be switching the entire IRA. In some cases you may want or need to switch only part. If you make this choice, you’ll need to divide the earnings between the part you’re switching and the part that stays behind according to an earnings allocation rule.
Consequences of switching
When you switch a contribution to a different IRA according to these rules, the new IRA is treated as if it received the contribution in the first place. You’ll also treat the new IRA as if it had the earnings that were actually generated in the old IRA and transferred over when you switched contributions. A recharacterization transfer doesn’t count as a rollover for purposes of the rule that says you can only have one rollover per year.
Example: You made a $2,000 regular contribution to a traditional IRA in February 2018. In March 2019 you decide you would have been better off with a contribution to a Roth IRA, so you switch the full amount, which at that point is $2,300. Your new Roth IRA is treated as if it received a $2,000 contribution in February, 2018 and had $300 of earnings, even though this Roth IRA didn’t exist when you made the original contribution.*
* If a baseball manager decides to bring in a pinch hitter in the middle of an at-bat, the pinch hitter inherits the count of the hitter who was batting. The IRA substitution rule is sort of like that.
Your decision to treat the transfer from one IRA to another as a recharacterization transfer is an irrevocable election. That means you can’t go back later and say you really meant to treat that transfer as a rollover or other contribution.
Example: After making the switch described in the preceding example you decided for some reason you would have been better off if you had simply converted the traditional IRA to a Roth IRA instead of making an recharacterization transfer. Too late! You have to make that choice before you make the transfer.
The fact that this election is irrevocable doesn’t prevent you from making subsequent changes in the IRA that received the transfer. For example, if you use a recharacterization to switch a contribution from a Roth contribution to a traditional IRA contribution, at some later date you can still do a Roth conversion, getting these dollars back into a Roth IRA, if you so choose.