Recharacterization without direct transfer?
I had an existing Roth IRA at one brokerage and decided to transfer the assets to a new custodian. Direct rollover was not possible, so I withdrew all funds from the first brokerage and made an identical deposit to the new brokerage within 60 days. This was done in about September of 2007.
I made a contribution to my Roth IRA (at the new brokerage) in October 2007 and determined earlier this year that I was ineligible to contribute. I also have a Traditional IRA with the same brokerage and have made zero contributions to it in 2007. I contacted them asking how I could recharacterize the 2007 contribution + earnings into my TIRA with them. They said that they do not have the capability to perform a direct transfer of cash between the accounts even though they are the custodian for both the Roth and Traditional IRAs.
Because the filing deadline is approaching, I withdrew my excess contribution + earnings (reported to the custodian as a correction of excess contributions) from the Roth and currently have the funds in my possession. Can I deposit these funds into my TIRA and have it count as a recharacterization since there is no direct way to get assets from the Roth directly to the Traditional? I should also add that I am not eligible for a tax deduction on contributions to the Traditional IRA in 2007,
Permalink Submitted by Alan Spross on Tue, 2008-04-08 00:46
Your new IRA custodian certainly does not appreciate your business. Their response to your request has either been misunderstood or they are arbitrarily refusing to comply with a routine taxpayer servicing request to provide the direct transfer necessary to enable you to comply with tax requirements. Unfortuneately, your attempt to work around their lack of cooperation will not work because the recharacterization must be done by direct transfer, not by rolling over the funds. Moreover, you cannot roll the latest back to the Roth because you rolled over funds into that account within the prior 12 months. Following is pasted from the IRS Regs regarding recharacterizations. This is the first report I have heard that an IRA custodian would not provide recharacterization transactions.
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Q–1. Can an IRA owner recharacterize certain contributions (i.e., treat a contribution made to one type of IRA as made to a different type of IRA) for a taxable year?
A–1. (a) Yes. In accordance with section 408A(d)(6), except as otherwise provided in this section, if an individual makes a contribution to an IRA (the FIRST IRA) for a taxable year and then transfers the contribution (or a portion of the contribution) in a trustee-to-trustee transfer from the trustee of the FIRST IRA to the trustee of another IRA (the SECOND IRA), the individual can elect to treat the contribution as having been made to the SECOND IRA, instead of to the FIRST IRA, for Federal tax purposes. A transfer between the FIRST IRA and the SECOND IRA will not fail to be a trustee-to-trustee transfer merely because both IRAs are maintained by the same trustee. For purposes of section 408A(d)(6), redesignating the FIRST IRA as the SECOND IRA will be treated as a transfer of the entire account balance from the FIRST IRA to the SECOND IRA.
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Based on what you have already done as a result of this custodian, you cannot recharacterize the excess contribution, but at least you have corrected it by taking the distribution. The earnings will be taxable and subject to a 10% early withdrawal penalty on your 2007 return. Unless you had a large earnings amount on this contribution, there is not much damage here since you cannot deduct the TIRA contribution. Under current tax laws there is very little advantage of a non deductible contribution vrs a tax efficient investment in a taxable account.
However, I would be concerned with your current brokerage. Perhaps you just talked to a poorly trained person there who provided you with the wrong response.
Permalink Submitted by Denise Appleby on Tue, 2008-04-08 02:08
Just to add, you can still make a regular contribution to your traditional IRA. The difference is …with the recharacterization, the earnings would have been moved along with the contribution to the traditional IRA. With the distribution from the Roth and contribution to the traditional, the earnings are not credited to the traditional IRA. Except for that, your end result in the same.
I know someone who had to transfer their Roth IRA to another custodian, just to get their recharacterization done. Apparently, their system was not designed to facilitate recharacterizations. Unbelievable…especially with recharacterizations being done for almost ten years.
Permalink Submitted by Amit Patel on Tue, 2008-04-08 12:29
What is the reasoning behind the trustee-to-trustee requirement for recharacterizations? If I notify my trustee before making the transfer into the TIRA that I’m doing it as a recharacterization, and they report it as such in the 1099-R and I report it as such on my 2007 return, will I be okay? Keeping the earnings, paying the penalty/tax and just making a regular contribution to the TIRA won’t kill me, but the earnings aren’t an insignificant amount, and I’d like to get them into the TIRA if at all possible.
From Publication 590:
To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer.
What does “generally” mean? There are exceptions?
Permalink Submitted by Denise Appleby on Tue, 2008-04-08 12:55
[quote=”patela2″]…the earnings aren’t an insignificant amount, and I’d like to get them into the TIRA if at all possible.
quote]
You cannot get the earnings into the TIRA at this point, at least not as earnings. Any amount deposited to the traditional IRA now will be part of the regular IRA contribution, subject to the contribution limit of $4,000($5,000 if you were at least age 50 by 12/31/2007).
Permalink Submitted by Janine Janine on Tue, 2008-04-08 14:39
[quote=”[email protected]“]
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Under current tax laws there is very little advantage of a non deductible contribution vrs a tax efficient investment in a taxable account. /quote]
I have felt that way ever since the Roth IRA was introduced! Incomprehensible to me, many of my friends do not agree with me.
Permalink Submitted by Amit Patel on Tue, 2008-04-08 15:50
[quote=”[email protected]“]Under current tax laws there is very little advantage of a non deductible contribution vrs a tax efficient investment in a taxable account.[/quote]
[quote=”[email protected]“]I have felt that way ever since the Roth IRA was introduced! Incomprehensible to me, many of my friends do not agree with me.[/quote]
I agree, starlight, at least for the non-deductible contributions to a Traditional IRA. Earnings would be taxed either way (though at different times). The tax-free earnings of the Roth IRA make it a great idea, though, in my opinion.
The only reason I want to make non-deductible contributions to a TIRA now is so I can roll those contributions into a Roth in 2010. I don’t expect to be able to make Roth contributions for the next few years at least, so this is the next best thing. I might just keep the contributions to the TIRA as cash in that account between now and 2010 to minimize the earnings (and therefore tax) in 2010 during the rollover. I posted about recharacterization to see if I could ultimately squeeze as much money into my Roth IRA as possible. Missing out on tax-free growth and withdrawals of a few hundred bucks today hopefully won’t have a huge impact on my savings at retirement :D.