Recharacterization of Deceased Spouse Roth IRA
spouse converts trad ira to roth jan 2010. he passes away in Aug 2010 – brain cancer. wife has no knowledge of roth conversion nor does she understand what it is. wife does a custodian transfer from one brokerage house to another & assumes the roth ira as her own. she then finds out about the conversion he did in jan 2010. wife wants to recharacterize but is not sure if it is possible due to her assuming the ira before recharacterization. thanks. if wife cannot recharacterize she is looking at paying taxes on a 620K conversion that is now worth 320K. Any thoughts?
Permalink Submitted by Bruce Steiner on Tue, 2011-07-12 22:32
Under the regulations, it’s the executor who can recharacterize. Treas. Reg. § 1.408A-5 A-6(c).
Permalink Submitted by Alan Spross on Wed, 2011-07-13 00:17
Bruce, could you comment please:
This question came up a few months back, mostly with respect to the affect of a spousal ownership assumption vrs the Roth remaining in inherited title at the time of the recharacterization decision. Since under a spousal rollover the spouse is treated as if they had owned the Roth all along for taxation purposes, the recharacterization option for the spouse would likely still apply. It also appears that if a non spouse inherited a portion of the Roth, the responsible party could opt to make a different recharacterization decision for the spouse vrs the non spouse.
However, there are also legal issues here that I expect the IRS wants resolved prior to any action. Here is the IRS Reg:
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(c) The election to recharacterize a contribution described in this A–6 may be made on behalf of a deceased IRA owner by his or her executor, administrator, or other person responsible for filing the final Federal income tax return of the decedent under section 6012(b)(1).
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What if the executor is not the spouse and disagrees with the spouse? While the final return is usually a joint return, how does that square up with making the surviving spouse “responsible” for filing it, or does the executor trump the spouse if their wishes differ?
And what if the beneficiaries on the Roth conversion differ from the beneficiaries of the TIRA? Can we assume that a recharacterization would have to go to a different TIRA account established with the same beneficiaries listed on the Roth conversion account on DOD?
Permalink Submitted by mk foss on Wed, 2011-07-13 00:55
To add to Alan’s questions:
Why would the custodian take direction from the executor when the IRA is set up to pass by beneficiary designation? I don’t know of any other circumstance where the executor has any standing to deal with an asset that is not part of the estate.
Permalink Submitted by Bruce Steiner on Wed, 2011-07-13 23:04
In response to Mary Kay: by recharacterizing, the executor isn’t dealing with the IRA, just the tax treatment. The interesting questions are (i) how the executor is supposed to determine whether to recharacterize, and (ii) whether there should be an equitable adjustment if the beneficiaries of the IRA are different from the residuary beneficiaries and the executor either recharacterizes or does not recharacterize.
In response to Alan: I haven’t thought through the mechanics of this, and am not aware of any authority on it. This is relatively new. Roth conversions have only recently become available to taxpayers with income over $100,000, and in order for this issue to arise, the IRA owner would have to convert and then die during the recharacterization period; and the executor would have to determine that it made sense to recharacterize.
Except in divorce proceedings in some states where the matrimonial court sometimes requires the recalcitrant spouse to file a joint return (courts in different states have gone different ways on this), no one has a duty to file a joint return. If one spouse dies, his/her executor and the surviving spouse can file a joint return if both of them wish to do so. Otherwise, they can file separate returns. If no executor or administrator has been appointed, the surviving spouse can file a joint return on behalf of himself/herself and the deceased spouse. However, if an executor or administrator is subsequently appointed, he/she has until 1 year after the due date of the surviving spouse’s return to disaffirm the joint return by filing a separate return for the deceased spouse, in which case the return filed by the spouse is treated as a separate return. Section 6013(a)(3).
Permalink Submitted by mk foss on Thu, 2011-07-14 00:41
Thanks Bruce but I still don’t understand. Let’s say that Dad does a Roth conversion from the traditional IRA where Mom is the beneficiary and names Floozy as the beneficiary of the Roth. If son (or Mom) is the executor how can they direct the Roth custodian to recharacterize. The custodian has a duty to the beneficiary (I’d think) but absent a provision in the adoption agreement requiring the custodian from delaying any distributions upon the death of the owner until the recharacterization deadline – I think Floozy is the only one in control.
I know Floozy, she’s a very sweet girl.
Permalink Submitted by Bruce Steiner on Thu, 2011-07-14 04:06
The regulation only says that the executor can recharacterize the Roth IRA back to a traditional IRA. It doesn’t say how.
In Mary Kay’s example, if the executor were to recharacterize, perhaps Floozy should remain as the beneficiary.
This still leaves the question as to how the executor is to decide whether to recharacterize (for example, if the benefit to the estate exceeds the detriment to Floozy), and if so, whether the executor must or may or may not make an equitable adjustment (in other words, compensate Floozy for the detriment to her from the recharacterization).
Permalink Submitted by Alan Spross on Thu, 2011-07-14 04:32
Since the intent of this provision is to allow for a more desirable tax outcome, although the code does not say so, any recharacterization would seemingly have to go to a new TIRA if the former TIRA had a different beneficiary than the Roth conversion. The beneficiary of the Roth should still get the funds, but the value of those funds are certainly greater when received in a Roth IRA than in a recharacterized conversion TIRA. That beneficiary would then lose out on the amount of taxes due on the TIRA, which would effectively be diverted to the estate that could have a different beneficiary.
A partial recharacterization would be allowed if a full recharacterization were allowed. In the case of multiple beneficiaries it could turn into a mix and match mess.
Permalink Submitted by Bruce Steiner on Thu, 2011-07-14 21:13
The question then becomes whether the estate has to reimburse the beneficiary of the IRA (that the executor recharacterized) for the income tax she’ll have to pay on the IRA benefits.
The executor might nevertheless recharacterize if it provided an overall tax benefit.
This probably won’t happen very often where the beneficiary is someone other than the spouse. The IRA would have to drop substantially in value between conversion and recharacterization. If the executor recharacterizes, a beneficiary other than the spouse won’t have another chance to convert.
This might happen where the spouse is the beneficiary and the IRA declined in value after conversion. The spouse can convert at some future time, or can spread the conversion over a number of years. If the spouse receives the marital share of the estate, the spouse would benefit from any reduction in the income tax on the decedent’s final return.