Your choice. You can move back any holdings you wish including of course cash eg MM fund. Only the VALUE of the recharacterization matters, and that value is the earnings adjusted amount.

Since you apparently have much more in this Roth account than just the recent conversion, the earnings calculation must include ALL the earnings experience in the Roth, not just that of the 1,000 shares you just converted. Your IRA custodian will usually calculate HOW MUCH must go back to the TIRA, it could be more or less than 30,000. Of course the exact figure will change daily with the market. Therefore, you will probably have to just tell the custodian to move back the number of shares needed to generate about 90% of the recharacterization amount and tell them to take the rest from your cash holding. But you can actually recharacterize any holding you wish.

You seem to have the reconversion limitations under control by having other TIRA assets to do the second conversion before you recharacterize.

In the future, if you want to avoid the complexity of the earnings calculation, convert to a new Roth account. That will eliminate the involvement of the rest of the assets in the earnings calculation (or as we know it now, the loss calculation)……..

The IRS worksheet you refer to contains the formula to determine the earnings calculation. It is in Pub 590, p 31.

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If the total of the Roth balance during the conversion period is only down 3-4%, it is not likely to be worth recharacterizing UNLESS Vanguard will partition the accounts now with appropriate earnings that would lead to a loss of 10%+. Since both these figures are subject to different but possibly large fluctuations over the potential recharacterization period, it might be best to press Vanguard to do the partition, but then wait to see if it is worth it to recharacterize later on. It will make the decision easier if the worksheet can just be eliminated by having the conversion in an account by itself.

You can still do the second conversion to yet another new Roth, and later on make the decision whether to recharacterize one of them, both, or neither. A benefit of conversion and recharacterization decisions is that some hindsight can be applied including known marginal tax rates for the year of conversion.

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Ted,

Thanks, but I was slightly surprised when you indicated that Vanguard agreed to partition the account, likely because your application left no doubt that it was solely their fault. Hopefully, they documented the preliminary agreement to revise in case you get a different rep.

A 1099R is issued to report the recharacterization and a 5498 for the companion contribution. This is issued in January following the year you recharacterize. If you recharacterize a 2008 conversion after 12/31, the 1099R will not be issued until January, 2010. But it will be coded to show a prior year recharacterization (ie year prior to 2009, which is 2008).

Since the IRS will not have that 1099R when you file your 2008 return, they request that you attach a narrative statement to your 2008 return. That statement might read – ” On xx/xx/2008 I converted $y to my Roth IRA, and on xx/xx/2009 I recharacterized the entire conversion, which was then valued at $z, back to my traditional IRA”. That will explain to the IRS why you are not reporting taxable income for the conversion 1099R that you will both receive. You can view some examples of this on the Inst. for Form 8606, p 3 which you can download from the IRS website.

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Ted,
If they are going to use both accounts for the earnings calculation, then there was no reason to partition the accounts. Apparently, in their mind that partition is not retroactive and therefore Conversion #1 involves a period of time when the accounts were combined followed by a more recent period when they are separate.

The advantage of being able to send less dollars back to the TIRA based on the greater loss for the assets you actually converted as been lost if Vanguard insiste on using both accounts because the separation was not done retroactively.

The instructions on p 31 of Pub 590 dictate that the earnings calculation include the accounts that contained the conversion and spin off account from that account (transfers), so the whole issue boils down to whether they will consider the partitioned account to be fully retroactive to your conversion date or just a split that was done later. It will make a major difference on the amount to be recharacterized to the TIRA. Obviously, the less the better (more in Roth = less in TIRA).

I suggest you try to talk to a specialist regarding the nature of the partitioned account, why it was done, and how it defeats the purpose if the split is NOT done retroactively.

The IRS will go strictly by the 1099R forms issued by the custodian, but in either case, you tax bill for that conversion will be eliminated. The problem is that too much is being sent to the TIRA, and that will affect later taxes, not current taxes.

This is confusing, so hope you can follow it……….

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I attach a link to the actual IRS Regs, which are a higher authority than any IRS Pub such as 590. Note Q&A #2, and item #4 in the answer. It could not be more clear in this case that the partitioned account is the ONLY IRA account under which the earnings calculation is determined.

http://www.taxalmanac.org/index.php/Treasury_Regulations%2C_Subchapter_A…

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Ted,
It is even more frustrating to have Vanguard take this position after agreeing to partition the accounts. Don’t give up until the IRA Dept Rep contacts you. It’s possible that they are not considering the account partitioned for purposes of the original conversions even though this was the only reason to split them up.

If they persist however, you cannot correct the problem through the IRS because either way, the recharacterization will erase the tax impact. The problem with what Vanguard is doing is that too many dollars will go back to the TIRA if they use a calculation that has a lower loss than your actual converted holdings. You want less to go back to the TIRA, ie more left in the Roth vrs the TIRA. Unfortuneately, telling the IRS that the IRA custodian transferred too much to the TIRA may not get any attention since it has no affect on the current return, and the IRS may ignore the fact that you will have to pay additional taxes years later.

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Ok, thanks.
But you will eliminate your income tax doing a full recharacterization no matter how they figure the earnings. So no worry there.

The potential problem is that they will figure the earnings incorrectly by using both accounts and that will result in too much going back to the TIRA.

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Sorry to hear of their decision, but thanks for posting the result as we can all learn from it. I assume you took this as high up the authority level at Vanguard as you were able to. I still cannot figure out why they originally bothered to partition your Roth if they were going to consider the accounts as one combined account anyway.

That said, earlier you indicated that the relative difference in losses between the converted assets and the rest of the Roth IRA was around 7%. That’s a fairly minor difference and will not result in many extra dollars going back to the TIRA than if Vanguard did this correctly. They may well have a reason for taking this approach that is different from the one they gave you, because we both know that the IRS Regulation on this was very clear. Perhaps they want to discourage recharacterizations, but if recharacterization is a big expense for them they should charge for them rather than making up rules as they go.

If the recharacterization results in more going back to the TIRA than the value of the converted assets, then another asset in your Roth will have to contribute to the difference, and you should be allowed to pick the asset, whether a stock or MM fund. Another result of this would be that the seperate Roth holding the conversion will be emptyied totally and a very small amount from the original Roth will have to be added to bring the total up to their calculation figure of the total earnings loss.

Since they insist on considering your two Roths as combined, then you should be able to select any holdings you wish in either account to be used to complete the recharacterization.

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Yes, the other 6,000 will have to come from the other assets. If you did the worksheet correctly, you now have a fairly small % loss on the total of both Roth accounts because your losses are quite small on the assets you had all along.

If you can afford the tax bill, perhaps you should wait on the recharacterization to see if a larger loss develops. You have until next October to recharacterize should the loss widen. If the aggressive investment recovers somewhat, you might even have a gain. The way Vanguard is combining these accounts, there is less of a reason to bother with the recharacterization at this time, just based on a small overall % loss.

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