Roth Recharacterization
Client wants to recharacterize some of last year’s Roth conversion back to his IRA. I thought that we should calculate the amount that he wanted to leave as his 2008 conversion plus the earnings attributable to that amount. However, I came across a source I have long trusted that indicates that we would recharacterize everything except the amount that the client would have converted last year irrespective of the earnings on that amount. Which is it?
For example, client converted $200K to a Roth in 2008. Now wants to retroactively make the converted amount $100K. Since the time of the conversion, the account is up 20%. Shouldn’t we leave $120K in the Roth and recharacterize $120K? Or is my trusted source correct in saying that we should leave only the $100K?
Permalink Submitted by Alan Spross on Mon, 2009-10-05 23:05
Your initial thinking is correct, and the trusted source should now be less trusted :).
$120,000 is the amount that must migrate back to the TIRA. The earnings calculation is done on the entire Roth first and then the % that is being recharacterized (50%) of the earnings adjusted conversion amount goes back to the TIRA.
200,000 conversion plus 20% gain = 240,000
240,000 X % of conversion recharacterized (50%) = 120,000.
It is rare that a client would want to recharacterize a conversion with a 20% gain, since the effective tax rate on the conversion is reduced considerably when there is a large gain. Usually, these examples assume losses on the conversion and the desire to erase the tax bill on phantom values.