Question on Recharacterization of Conversion from Traditional to Roth IRA

Submitted by Terry Koch on Wed, 2016-10-26 02:07

I converted a bond from my traditional IRA to my Roth IRA in April 2016. The value of the bond at the time of conversion was approx $15,000. The bond is now worth $12,000. The total value of the Roth IRA prior to conversion was $499,000. It is now valued at $524,000. Based on the IRS net income formula, the net income on the recharacterization = $788. I was planning to recharacterize the conversion of the bond, but after doing some research, I am coming to the conclusion that I can’t just recharacterize this single security, but rather a calculated dollar amount based on the conversion value ($15,000) + net income ($788). Thus it appears that there is really no benefit in doing a recharacterization of the conversion. Am I looking at this correctly or would there be some benefit in doing a recharacterization?



Submitted by Alan - IRA critic on Wed, 2016-10-26 02:27

  • Unless you have another reason to recharacterize such as a tax bill at a higher rate than you anticipated, a recharacterization will not be beneficial because your conversion has generated a 5% gain based on the overall performance of the Roth, notwithstanding the fact that the bond has been a loser. Recharacterizing would send 15,788 back to your TIRA, making that 788 eventually taxable. Not a good deal.
  • But it does illustrate the benefit of converting to a newly opened Roth account instead of an existing one. When you convert to a new Roth, there is no earnings calculation necessary because the account holds only the conversion, so the current value of the account would be the amount transferred. Converting to an existing account dilutes the earnings calculation and this can work either in your favor or against you. In this case, it worked against you.
  • FYI – IF you recharacterized this conversion you would usually be given an opportunity to choose which investments would transfer to the TIRA. If you selected the bond at 12,000, you would need to add another investment or two whose shares were worth the 3,788 difference.

 



Submitted by David Mertz on Wed, 2016-10-26 12:32

  • I calculate the earnings to be only $292 = 15,000 * ((524,000 / (499,000 + 15,000) – 1)
  • With an overall gain in the Roth IRA, it doesn’t make sense to recharacterize just because the particular bond investment lost value.  If the $15,000 conversion is recharacterized, in 2017 $15,292 (assuming no subsequent change in value) would have to be (re)converted to get everything back to the Roth IRA where it is now.  Recharacterizing would only make sense if you had a different reason for wanting to reduce 2016 AGI.


Submitted by Alan - IRA critic on Wed, 2016-10-26 17:29

Terry, DMx calculated the earnings based on your statement that 499k was your balance before the conversion, which is what you said. But the opening balance in the IRS formula includes the conversion value, which would make the adjusted opening balance 514k. Therefore, you should clarify whether your adjusted opening balance is 499k including the conversion or 514k including the conversion. Lower earnings makes recharacterization only slightly more viable than higher earnings, but not much more.



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