Roth Conversion and recharacterization
I have a husband and wife client. Both have IRA’s. In September we converted the wifes IRA to a Roth. We were looking to Recharacterize this conversion back to the wife’s Traditional IRA and then Convert the HUSBANDS IRA to a Roth. Would this violate the reconversion rules?
Permalink Submitted by Alan Spross on Thu, 2008-12-18 20:41
No.
Each spouse’s IRA is totally separate from the other. The reconversion rules apply only per individual. The tax forms these conversions are reported on is Form 8606 and there is a separate one for each spouse (SSN).
The explanatory statements recommended to summarize the conversion and associated recharacterization should also be separate for each spouse, if each one ends up recharacterizing.
Permalink Submitted by Bill Lohss on Fri, 2008-12-19 23:14
I have done the following transactions between my Traditional and Roth IRAs at Vanguard:
1) On 5/1/08 converted $17,500 Prime MM in Traditional to Prime MM in Roth.
2) On 6/2/08 converted $4,000 from Precious Metals Fund in Traditional to Precious Metals Fund in Roth.
3) On 6/16/08 re-characterized $3,000 Prime MM in Roth back to Traditional.
4) On 12/15/08 converted $8,000 Prime MM in Traditional to Prime MM in Roth.
Total of 3 conversions and one recharacterization involving one Traditional and one Roth IRA both held at Vanguard.
I have 2 questions:
#1: Am I in violation of IRS rules due to the $8,000 conversion from Traditional to Roth on 12/15/08 (which occurred after a recharacterization on 6/16/08 )? If so, how can I fix this so I don’t incur a penalty?
#2: Can I still recharacterize the $4,000 conversion of Precious Metals mutual fund shares on 6/2/08 from my Roth back to my Traditional IRA even though I have already performed one recharacterization already this year? I want to do this because the shares are now worth on $1,500.
I was told by a Vanguard rep that the answer to #1 is YES – that I shouldn’t have done that conversion because I had previously done a partial recharacterization of a previous conversion.
I was also told that the answer to #2 is NO. I can’t perform a recharacterization of the Precious Metals Fund conversion because of an IRS LIFO rule. In other words, any recharacterization performed now would have to apply to the most recent funds that I converted, which was the $8,000 I converted on 12/15/08
I find this all terribly confusing and can’t seem to find the information I need to make a determination, but I suspect the Vanguard rep might be wrong on both counts.
Permalink Submitted by Alan Spross on Sat, 2008-12-20 00:05
1) Depends on the details. I take it that you have only one TIRA and one Roth account involved in these transactions. If not, please clarify. Also, was the balance in your TIRA just before the 12/15 conversion at least $11,000? If so, you have NOT done a disallowed reconversion.
2) Sure, you can recharacterize any conversion you wish within the time limits. What you are doing is recharacterizing all or part of a specific conversion, ie an AMOUNT. The particular holdings you choose (or the custodian chooses) are immaterial. In fact, many people have long since sold the holding they originally converted and replaced it. I have never heard of any LIFO rule, and if the Rep persists, ask for a cite from the IRS Regs.
Permalink Submitted by Bill Lohss on Sat, 2008-12-20 02:21
Thanks for your reply. There are just 2 IRAs involved: a TIRA and a Roth. Yes the TIRA was greater than $11K before the 12/15 Roth conversion. Why is $11K important?
I was concerned that the rule that you cannot convert – recharacterize- reconvert within the same year would apply. That is, I originally converted $17,500, then $4,000 for a total of $21,500. The source was the TIRA. Then I recharacterized $3,000 back to the TIRA. Finally, I just converted another $8,000 from the TIRA to the Roth. So it looks like a conversion – recharacterization – reconversion.
Assuming that the above transactions are OK, which you indicate they may be, then the remaining issue is recharacterizing the $4,000 conversion of shares in the Precious Metals Fund. The goal of that would be to “undo” the $4,000 Precious Metals Fund conversion which now has a value of $1,500. I want that to be “as if” I never did it in the first place, so I’m not paying taxes on a $4,000 conversion that now has a much lower value. How do I do that? I thought that Vanguard would be able to track the depreciated value of the $4K conversion and that would be the amount recharacterized back to the TIRA and reported by Vanguard to the IRS. Is that correct? I really don’t care about re-converting in order to replace those depreciated shares in the Roth, I just want to avoid the taxes on a depreciated conversion by undoing it. Thanks.
Permalink Submitted by Alan Spross on Sat, 2008-12-20 04:46
Since you recharacterized $3,000, you may need to show that the $8,000 was not a disallowed reconversion or you would be in violation. However, if you had at least $11,000, then your last conversion of $8,000 did not have to include any of that $3,000 that you recharacterized. In other words, your last conversion was a totally different amount of assets than what you recharacterized on 6/16. So you should be OK here – no disallowed reconversion committed. But keep a copy of a statement that shows this balance just in case.
You must identify which conversion you are recharacterizing when you order it. The holdings you use are not used for this purpose because you can use any holding you wish. Therefore, your $3,000 recharacterization could have been a partial recharacterization of either of the first two conversions. Since the prime MM was used, the partial recharacterization was probably for the first conversion. In any event, you identify that by the date of the conversion, not by what holdings you used.
Therefore, since you also want to recharacterize the 6/2/08 conversion, you will tell Vanguard that you want to do a total recharacterization of the 6/2 conversion and you want to use the Metals fund. Note that it is very possible that due to the earnings calculations, you may not have enough of the metals fund to fund the entire recharacterization and may have to use some of the other assets. So you would tell Vanguard to use the metals fund first, and if that is not enough, complete the recharacterization with the “xxx” fund. This happens because the earnings calculation for each conversion includes the earnings of the other assets in the Roth IRA at the time, and they have different earnings obviously.
This will erase the 4,000 conversion. You would be left with a tax bill for $22,500 in conversions for 2008. (17.5 + 4 -3+8-4 = 22.5)
Try to get someone else at Vanguard because they either do not understand the process or are getting confused.
I think possibly there are so many recharacterizations being done that they must have quickly trained extra staff to handle them, so some of the staff might not be experienced. Ask for a senior person, if possible. There has also been confusion because Vanguard uses a complex account platform instead of just one brokerage TIRA and Roth IRA.
Permalink Submitted by Bill Lohss on Sat, 2008-12-20 12:47
Thanks once again. Everything you say makes perfect sense to me. I agree that the rep at Vanguard doesn’t know what he is talking about. It should be possible to recharacterize any previous conversion. Since there was a previous conversion of $4,000 representing the Precious Metals Fund then I should be able to recharacterize that specific conversion. My understanding is that they should then transfer the same number of shares + earnings back to my TIRA. The current value of this holding is approximately $1,500 so I would be “undoing” a previouis taxable conversion of $4,000 – which is my intent. I would think this would be a common enough procedure that there wouldn’t be any problem, but this Rep seems to think that he can only recharateracterize $4,000 of the $8,000 conversion I did on 12/15 which seems totally nuts to me. Thanks for your guidance. I will try to talk with someone else at Vanguard to get this executed properly. It bothers me that they have staff who are so unknowledgeable about this.