Jack,
The strategy is fine. You are not making any disallowed reconversions because you are not reconverting in the same year as your recharacterizations or within 30 days, if later.

Of course you must correctly report the conversions and recharacterizations on your return, and that includes an explanatory statement. Your situation is simpler than many others, however, becaue you will complete your recharacterizations in the same year as the conversion and receive all the 1099R and 5498 forms in the following January, so the IRS can easily see what you have done. In addition, there is no need to extend or amend your tax returns due to recharacterizations done closer to the deadline.

I assume you are filing jointly because of your stated top of the 15% bracket, but if the 70,000 is correct, you must not have much other taxable income or your TIRA includes a hefty basis of non deductible contributions or rollovers. Perhaps you are delaying your SS retirement claim to keep your conversions from resulting in 85% of your SS income being included in AGI and the increased marginal tax rate that would cause. That would also be a good strategy if you are in good health, particularly if you are the high income earner of the couple.

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Your actual holdings at the time of recharacterization do not matter. The earnings allocation, in this case negative, follow the same formula regardless of changes of holdings, and Vanguard should have no trouble doing the calculation.

The small gains in the MM fund will slightly offset the losses in the calculation. I am not sure if your 3 conversions were into separate Roth accounts or into a single Roth, but the calculation method is the same and applies separately to each account. Obviously, if each conversion is made to a separate account, there is no real calculation required since the difference in the account balance simply determines the earnings allocation.

Actually, the recharacterization process is easier for Vanguard if everything is in the MM fund. That way, they do not have to ask you how much of each of the remaining funds will migrate back to the TIRA.

Again, investment considerations almost always trump tax issues, so if you need to limit your losses to sleep at night, then by all means do the exchange to the MM fund. You could also change to the MM fund now and if the market starts to recover, exchange back into equity funds prior to doing the recharacterization. The number of changes you make will not make the calculation any more difficult than if you did no changes.

I believe that Vanguard does these calculations, but if they refuse for some reason, it is their right to require that you come up with the calculation yourself. There are worksheets in Pub 590 for this purpose, but the main problem is that once the calculation is done, the recharacterization must be done the same day, since the values change every day, lately by hugh amounts.

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Jack,
I can vouch for the conversion information provided by Fairmark and Kaye Thomas. He is a noted authority on Roth conversions and has published books on the subject.

Your confusion here is understandable given the complexity of your situation. The worksheet formula for calculating earnings, in this case negative earnings, applies to the investment experience of the entire Roth IRA account during the period of time the conversion exists. This is simple when you do each conversion into a new Roth account because there is nothing else in the account but the conversion itself, and therefore the earnings are simply the difference between your conversion and what the account is now worth.

Based on your post, I am assuming that you made all these conversions into a single Roth IRA account. If so, each conversion exists for a different time period and is affected by the losses on the other conversions as well as those of the Roth that existed prior to April. Vanguard will use software to figure out what the earnings loss is for each conversion that you wish to recharacterize. If all 3, then 3 calculations are needed.

If you HAD done each of these conversions into a separate Roth, then the actual dollars that would go back to the TIRA in a recharacterization would be the same as your posted numbers. To erase the tax bill on 143,005, only 117,950 would go back to the TIRA. If you had sold the Funds on 11/28, then 117,950 in Money market fund cash would be what would have gone to the TIRA. However, since you converted into a single Roth account, the earnings loss for each recharacterization will not be the same as you indicated because the funds are all commingled together.

Vanguard is correct to give you your choice on what holdings you want to go back to the TIRA, but no matter which you select, the value must add up to the what the earnings calculation indicates must be recharacterized.

The values you posted seem to indicate that the Roth IRA is almost exclusively equity based, with very little in cash. The entire account has tracked the market down, and therefore there is probably not a huge difference between your number of 117,950 and the correct amount to be recharacterized according to the actual calculations.

Providing Vanguard with your instructions should be fairly easy. Decide which investments you most want to have in the TIRA. Then tell them to fund the recharacterizations in order, eg first use up Fund A, then the ETFs, then Fund B etc. In making the decision, send back the worst of the holdings and retain the best ones in the Roth, no matter which conversion they were associated with. If you have losses, better in the TIRA and for gains, better in the Roth for obvious reasons.

There is NO requirement to recharacterize the same holdings that you converted, in fact many investors have long since bailed out on what they actually converted and may have gone to cash. In that case, it’s the cash that is recharacterized. In your case, even though you converted the ETFs LAST, you can make them the first holdings to complete the first conversion recharacterization if you wish. Vanguard should have no problem doing fractional share recharacterizations or for that matter conversions.

There does not seem to any obvious conflict with what Vanguard is asking and the correct rules. They just want to give you your choice on what holdings move back. The main risk to you in this entire process would be if their calculations are wrong and they send back too much to the TIRA. The less sent back the better. Again, no matter how much goes back, your tax impact is the same. You will have erased the tax bill on conversions that have dropped substantially in value.

I know this is confusing, but hope this helps.

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Alan
I’ve had discussions with the OP on another forum and it sounds as if he has also learned how VG treats losses. You may recall you helped me in my battle with them. They would “not” deal with my roth1 and roth2 individually.
However, reading your reply to him re partioning, I’m confused. Do you still feel that VG will/should treat the accounts individually.
I’m still trying to figure out whether I should recharacterize other roth assets to make up the loss. It seems like a wash from tax standpoint.

Thanks for your incredible patience with us amateurs.

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Alan
Thanks for your response. I’m wondering if you have any suggestions how to deal with this at VG. This topic is being discussed on the” Boglehead” forum and you and Fairmark are regularly quoted .
As you know, I went up the ladder at VG and received a very clear message. It never changed from person to person. They combine all their Roth accounts no matter of the title. In their eyes, the IRS Regs only refer to accounts with different custodians like Fidelity etc.
The fact that my account was corrected never entered the discussion.

My particular situation is not all that critical anymore with my presently reduced loss. I’ve resigned myself to paying tax on the unconverted amount expecting taxes to be higher down the road.

Would it be possible for you to discuss this issue with the VG IRA dept as a counselor to many of their members. Perhaps, I have misunderstood this whole mess.

Thank you for your consideration, Ted

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Alan
Thanks for taking the time to talk to Vanguard. I was not able to get to the same Annie you talked to, but went thru the whole thing again.

Your comment about combining accounts vs different IRA’s is still a mystery to me. They insist that all Roths are combined in their computation. The retroactive account issue is not the problem looking at my case.

I have taken enough of your time and will just let this rest for now. Your efforts have been appreciated.
Ted

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Alan or whomever, I have another question????

I made 4 conversions from a T-IRA to a Roth in 2008. I’m recharacterizing the conversions of the first three dates.

04/03/08 $38,776 – prior Roth value 130,000
06/26/08 $31,768 – prior Roth value 164,000
10/23/08 $72,461 – prior Roth value 127,500
12/03/08 $50,000 equalling $193,005 total of all conversions for 2008.

Pub. 590 page 31 worksheet 1-3 ???????

On line 3 of worksheet does $193,005 get added to each calculation of the value of the ROTH immediately on day prior to the time of each recharacterization I am having done.
Ex. 04/02/08 Roth Value 130,000 + all 2008 conversions $193,005 =
$323,005….2nd date $164,000 +$193005 = $357,005….3rd date $127,500 + $193,005 = $320,505????? [b]Is this right?????[/b]

Also after doing each computation and line 7 of all three dates = $81,458 total and the conversions are now equalling $112,048. Does that mean I am able to recharacterize and put the $112,048 back in the T-IRA and still beable to have my $50,000 on 12/03/08 conversion be taxable???

I do realize that line 2 will change depending on when Vanguard does the recharacterizations which will effect what is put back into my T-IRA.

Alan, I what to thank you so much for being so patient with a taxable situation dummie.

TIA……………JACK

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The most important factor here is that they send the correct amount back to the TIRA. What particular assets are where is much less important because you can always rearrange that with no tax impact.

First, I noted your post opened with the statement that you recharacterized all 4 conversions. Apparently, you meant just the first 3, and not the final one. Also, your total for the first 3 is incorrect, it should be 143,005, not 153,005 if you correctly add up the amounts in your post.

Just ballparking that the market is down around 33% for the first two conversions and not much of a change for the 3rd one, it would indicate that about 120,000 should go back, and that is in the general ballpark of the 112,137 you indicated.

The amount you will be taxed on is not related to what particular assets are where after the recharacterization. It is strictly based on the amounts that you report in your explanatory statement on your return and what you show on the 8606. Since the last conversion is the only one left in place, that is the only one you will report on Form 8606, ie you will report a conversion of 58,000 only.

The explanatory statement will state:

“On 4/3/08 I converted 38,776 to my Roth IRA.
On 6/26/08 I converted 31,768 to my Roth IRA.
On 10/23/08 I converted 72,641 to my Roth IRA.

On 12/9/08 I fully recharacterized all 3 of the above conversions, which were then worth 112,137, back to my traditional IRA.”

I cannot comment on the amounts of the various holdings and in which IRA they are now located without seeing your actual recharacterization form. Or, it is also possible that Vanguard changed your order due to certain minimums on certain funds.

But there is no reason that you should be taxed on anything more than the 4th conversion, and where the various investments are now does not affect your taxes. It just affects where future gains or losses will occur.

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This is just a correction I made because of poor addition that Alan brought to my attention.

[quote=”[email protected]“]Well I recharacterized my four 2008 conversions on 12/09/08.

04/03/08 $38,776 – prior day Roth value 130,000
06/26/08 $31,768 – prior day Roth value 164,000
10/23/08 [u]$72,461[/u] – prior day Roth value 127,500
..equals..$143,005 for first 3 conversions
12/05/08 $58,000 equalling $203,005 total of all four conversions for 2008.

The Vanguard custodian form asked what conversions I wanted recharacterized.
I put down the first 3 conversion dates. Included 3 funds on the 1st and 2nd conversions and 3 ETF’s on the the 3rd conversion.

When Vanguard got done I looked and they had the 3 ETF’s value of 12/09/08(amounting to $67 more than the 3rd conversion) back in my T-IRA.

What has me confused is that they put back $13,203 and into each fund = $39,609 back into the T-IRA three funds. It left $200 and $400 into the 1st conversion funds left in the ROTH and left $8400 in the 2nd conversion fund.

After calculating I had $143,005 converted on first 3 conversions and after re-characterizing only $112,137 went back to the T-IRA.

I called Vanguard and asked why the first 2 conversions were not put completely back into the T-IRA. I said I only wanted to be taxed on the 4th conversion of $58,000. They said after checking and calling back a hour later that I would only be taxed on the $58,000 of the 4th conversion.

I was always under the assumption that all the funds and ETF’s of the first 3 conversions would be closed out and was very surprised to see around $9000 was left in the 3 ROTH funds of the first 2 conversions????

The reason they said they split the $39,609 in 3 was that they thought I would want to leave those funds open seeing those funds where minimum opening amounts on the 3 funds were $10K and $25 funds.

I have two representatives on recorded lines saying that I would only be taxed on the $58,000 of the 4th conversion.

[b]Does this sound right to you personal finance CPA’s and hobbists????????

Any input would be appreciated because I still feel uneasy that I’ll owe more conversion taxes than $58,000 of the 4th conversion seeing there is still $9000 left in the 3 funds of the first 2 conversions.[/b]

TIA…………………..Jack[/quote]

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1) No. A single conversion can include multiple different holdings. The IRS is only interested in amounts, not holdings. You can choose any combination of holding you wish if you are not converting a cash equivalent such as a MM fund. If you wish to recharacterize, you can use any holdings you wish that are still in the Roth when you recharacterize. In other words, if you convert shares of A and B to a Roth that already holds C, you can choose to recharacterize C back to the TIRA if you want to. Or you can sell A and B in your Roth and buy D and use D to recharacterize.

Because the recharacterization has to include an earnings calculation for all holding in the Roth including pre existing holdings, the amount for recharacterization can be far more or less than you actually converted. Because of this, there might not be enough value in A or B left to recharacterize, and some shares of C will have to be added to get to the right amount required. Again, the earnings calculation includes all the holdings in the Roth to determine an amount, but you should then be able to choose any holdings in the Roth you wish to arrive at the required amount to recharacterize.

2) While your first statement was not correct, there still is an advantage for doing separate conversions, but do them on different days so they can be identified. If you convert A to a Roth on 12/22, and B to another Roth on 12/23, you can avoid any earnings calculation because the account balance is automatically the amount that needs to be recharacterized, and if the holdings are still the same, all you do is call the custodian and tell them to recharacterize the 12/22 conversion. Some people will do two of these and recharacterize the worst performer only.

Conversely, if you recharacterize A to a Roth that already holds B in the same amount, and A loses 50% while B gains 50%, you have no net gain or loss since the amounts are averaged. If you wanted to recharacterize this conversion, there would not be enough value left in A to complete it and you would have to add 1/3 of B to bring the complete recharacterization value up to the original conversion amount.

Therefore, having separate Roth accounts does give you more control of each particular conversion with respect to recharacterization.

Finally, a recharacterization does not have to be total. If you convert 50,000, you can choose to recharacterize any % of that you wish. If you recharacterized half, then you would be left with a tax on 25,000.

The approach depends on what you want to accomplish with your conversion. If you convert a stable value holding, then you are not going to want to recharacterize because of losses. You can depend on using your tax bracket for the year and being done with it. On the other hand, if you do not mind recharacterizing and want to try to hit a home run in the market, you can convert or buy a holding in the converted account that is volatile. In this situation, you would intend to retain the conversion if the holding goes up, but if it drops x% you know you will want to recharacterize. If that happens, and your bracket is lower that year, you will lose that opportunity to use the lower tax rate because your recharacterization will wipe out the conversion.

This year is unique in that many conversions have lost big and need to be recharacterized. But if you have other assets in your TIRA that you did not convert, you can still convert them now and recharacterize the first one.

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Before I respond to your example, I need to know whether you did one conversion of 20,000 on the same date that was composed of two different holdings OR whether you did one for 10,000 on one date and the other 10,000 on another date. This determines whether you have done one conversion or two. The number of holdings does not matter.

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OK, then you would tell the custodian that you want to do a total recharacterization of the conversion dated xx/xx/2008. The custodian must then do the earnings calculation on the entire Roth account including all the other investments in the account. (This would not be necessary if you did each conversion into a new Roth account).

Let’s assume the stock mutual fund of 10,000 lost the most, but the overall loss is only 25% because you have MM funds in the Roth as well as other holdings. If the overall loss is 25%, then 7,500 is the amount that must go back to the Roth IRA. This is an IRS requirement.

But the holdings that go back are your choice. If you first want the stock shares that you converted to be recharacterized, they are now only worth 5,000. In order to come up with the extra 2,500 you will then have to send 2,500 of other assets back to the TIRA. Scenario A you posted does not take into consideration that the earnings calculation must include all the other assets. A would be correct if you had converted into a new Roth account. If the conversion was the only holding in a Roth, then no calculation is needed, you just send everything back.

Likewise, Scenario B starts out correct, but again overlooks the earnings calculation and the number it would produce. Using the above example with a 25% overall loss, you would only need 2,500 worth of other investments to bring your 5,000 up to 7,500. In this case you would tell the custodian to fund your recharacterization first with shares of the stock mutual fund you converted (give them the symbol) until they were used up, and complete the recharacterization with enough shares of (select another investment) to equal the 7,500.

Sending 7,500 back to the Roth STILL enables you to eliminate the tax on the full 10,000 of the conversion you recharacterized. You would show only the conversion that sticks on Form 8606, and would attach an explanatory statement to your return explaining the other conversion that you recharacterized including amounts and dates. No need to mention the particular holdings as the IRS does not care about that, only amounts.

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