TIRA Conversion-ROTH Recharacterization – IRS Form 590, 1-3
On May 8, 2008 I converted $44,392.89 of my Vanguard Capital Opportunity R/O IRA to a Vanguard ROTH in the same fund in my Vanguard Mutual Fund account.
On November 28, 2008 I recharacterized the subject $44,392.89 conversion back to the original R/O IRA.
On the date of the conversion, as well as the date of the recharacterization, I held additional ROTH IRA assets in Capital Opportunity, Primecap and Health Care in the same ROTH IRA account.
On November 19, 2008 I converted $48,526.29 of assets in 3 different equities from my R/O IRA to a ROTH IRA with Vanguard in my Brokerage account (a different account # than my Vanguard mutual fund account number).
QUESTION: Am I required to include all ROTH holdings in both the Vanguard Mutual Fund Roth account and the Vanguard Brokerage ROTH account (different acct. numbers) when completing the IRS 590 1-3 form. Vanguard says “yes, even though the Vanguard Mutual Funds and the Brokerage holdings are in different accounts, all these assets have the same account platform in the sweep account and therefore must be included in the 590 1-3 computation for recharacterization of the $44,392.89.”
What say you?
Permalink Submitted by Alan Spross on Thu, 2008-12-18 18:05
This issue has come up before with Vanguard earnings calculations for recharacterizations.
I called Vanguard and was assured that they follow the IRS guidelines that clearly indicate that earnings results ONLY include the account that holds each particular conversion. This is quite clear in the IRS Regs.
Another poster here ran into this problem, however in his case there was a partitioning of the Roth into which he made his first conversion into two separate Roth accounts. If this is done, then both accounts must be used since a particular conversion spent time in both the accounts.
In your case, I think you are probably correct that the platform they use between Brokerage and Fund accounts causes them to consider both accounts in recharacterizations. Did you create the brokerage account after doing the first conversion?
As you probably know, using more than one account can work for you or against you based on the earnings results, in this market being negative. The worse the results they consider, the less money is transferred back to the TIRA, which is good. You would rather have more of the investment loss in the TIRA than in the Roth for obvious reasons.
Beyond these possibilities, there is also the possibility that you are working with a Rep that is just getting it wrong, and perhaps a more senior staffer can explain better why they need to consider both accounts.
Permalink Submitted by Herm Brames on Thu, 2008-12-18 19:46
Alan,
Thank you very much for your quick reply.
Regarding your question as to whether I created the brokerage account after doing the first conversion–the answer is No, the Brokerage account was created in in November of 2003, the brokerage holdings were purchased in November and December of 2003 and my first conversion from my Vanguard R/O IRA mutual fund holdings occured in mid-2004. I have not previously converted any holdings from my Vanguard Brokerage holdings.
Your last paragraph confuses me a bit. Did you mean to close that paragraph with the word “separately”? As I understand your reply stated above, each account is to be considered separately when completing the IRS 590, 1-3 (the assets of the Brokerage account do not factor into the computations when doing my Vanguard Capital Opportunity recharacterizations).
How do you suggest that I get Vanguard to change the calculations for the recharacterization–ask for increasing levels of senior staffers until someone agrees to the change?
Herm
Permalink Submitted by Alan Spross on Thu, 2008-12-18 21:30
Herm,
No, I meant they need to explain why they use more than one account to figure recharacterization earnings.
Just speculating, but perhaps the reason is that they are using a single sweep MM fund for both Roths. If so, that sweep account would also be a Roth account, but perhaps it services both of the main Roths. That would effectively commingle the two accounts. Still fishing, but they do have a very cumbersome platform and I think it must be the reason they feel they must use both accounts for earnings.
They DO seem to be aware of the IRS Regs calling for only the account that held the conversion to be used to calculate earnings. But apparently their account platform causes this problem.
If so, they will NOT agree to the change not because they are unaware of the rule, but because their platform requires them to consider these two Roths commingled.
If it is any help, here is a link to the Reg – see #4 which is very clear:
http://www.taxalmanac.org/index.php/Treasury_Regulations%2C_Subchapter_A…
Permalink Submitted by Herm Brames on Tue, 2009-01-13 01:57
Alan, I’ve been out of town and on family business since Dec. 18th and have not had a chance to respond to your reply to me of the 18th. Your speculation is correct regarding the single sweep account used by Vanguard in that they include all ROTH accounts held at Vanguard in computing the put-back for any mutual fund or brokerage asset that you want to recharacterize, even if in separate accounts.
Since I last wrote you and subsequent to my last conversation with a Vanguard rep, I have received revised statements from Vanguard and now I am more confused than ever. Vanguard has now put-back $45,535.91 to my TIRA’s as a result of my recharacterizing a $44,392.89 ROTH IRA. As you can see, this is $1,143.02 more than I recharacterized. How can this be? There were no distributions on any of my ROTH IRA’s in the account during the period from my $44,392.89 conversion (5/18/08) and the time of my recharacterization of that amount (11/28/08). The fund value actually decreased in value by about 40%. I did however do another ROTH conversion of $48,526.59 in my Vanguard Brokerage account on 11/19/08 but those assets likewise sold lower on the recharacterization date of the $44,392.89 than on conversion date of the $48,526.59 Brokerage assets.
Alan, I have noted that most of the posts regarding ROTH recharacterizations have involved Vanguard. Since I also hold ROTH IRA assets with another Brokerage firm I called them and spoke to two different reps at two different times and presented the situation I’m dealing with at Vanguard. Both reps told me that if I had two different ROTH accounts at their firm and did a recharacterization of any ROTH holdings in any one of those accounts, only the assets in the account with the ROTH asset to be recharacterized would be used in computing the put-back. I was told that this Brokerage company had formerly combined accounts as Vanguard currently does but had changed their procedures some time ago in keeping with Treasury instructions.
If the information from Vanguard’s competitor is accurate, the following question is asked. If a Vanguard ROTH investor who converted assets in 2008 and planned to recharacterize those assets within the permissible timeframe and if the methodology of Vanguard in combining all ROTH accounts would be projected to negatively affect the amount that Vanguard would put-back into the TIRA, why would an investor not wish to consider transferring those ROTH assets to separate accounts at a competitor institution prior to the recharacterization of the subject assets if the subject firm had a more favorable recharacterization platform? In my case, the Form 90 Worksheet 1-3 arrives at a put- back number of $30,128.02 from my recharacterization of a $44,392.89 converted ROTH when including only the assets in the ROTH account in which the recharacterization is being made as opposed to the put back number of $45,535.91 when Vanguard uses all ROTH accounts at Vanguard for their computation. I’m told by the competitor reps that they would only ask the investor to look back and provide the conversion dates and values in the specific account holding the proposed recharacterization assets in order to complete the recharacterization at their firm. Continuing my specific case, the difference between Vanguard’s put-back and the competitor’s presumed put-back is $15,410.88 which in an assumed 28% marginal tax rate situation would cost an additional $4,315.05 in taxes if/when the extra put-back assets were to be reconverted.
Expanding further on the above question, why would not a Vanguard investor who wished to continue to hold Vanguard funds but who might wish to convert those assets to ROTH’s in 2009, want to consider transferring those assets to the subject competing institution in separate accounts? Should the “market” continue to tank in 2009, the competitor’s recharacterization process would seem to be more clear cut and allow each recharacterization to stand on its own. If one was inclined to want to hold all assets with Vanguard, could not one then transfer those assets back to Vanguard in the future assuming the funds in question were not closed and the amount in question was of the size necessary to invest in the specific Vanguard mutual fund?
I apologize for the lengthy post but I am quite frustrated. The way Vanguard has treated my recharacterization is not at all what I expected. There was absolutely no value whatsoever achieved by the recharacterization and in fact has been to my detriment. I would like to suggest that Ed Slott expand significantly on the recharacterization process including some pitfalls and things to consider in the next revision of his books. Thanks.
Herm
Permalink Submitted by Alan Spross on Tue, 2009-01-13 03:57
I agree that the VG account structure is cumbersome, and would guess it is derived from some sort of in house compromise between the brokerage side of the firm vrs the mutual fund side. That said, the way they appear to set up these accounts, they are probably doing the calculation correctly because of the commingling of assets. The problem would then lie with the account platform and not the actual calculations.
Depending on the investment results of the various accounts, this could work for the IRA owner or against him. In your case, it obviously worked against you because of the greater amount sent back to the TIRA. As you indicated, this does not cost you now, but will later on if you eventually reconvert those added amounts in the TIRA.
Due to this, Vanguard Roth IRA holders should get a quite before ordering the recharacterizations unless they MUST recharacterize. Some owners might wish to retain the conversion if the earnings allocation produces distorted results.
Permalink Submitted by Richard Poirier on Thu, 2009-01-15 01:12
Can you elaborate on how the scenario being discussed will be reflected on his 1040 Form? I also did three conversions and two recharacterizations with Vanguard. Although I am not in disagreement with how Vanguard handled my TIRA conversion I am confused by the proper reporting on my return. Two of the conversions were for the same fund, different dates and different amounts. Both recharacterizations were for these conversions. My 2008 1099-R has been posted on their site and they are showing two 1099’s being issued. The first: distribution code 7 and Box 2a: equals the combined conversion amount; the second 1099-R shows distribution code “N” with the distribution amount equal to what went back to my TIRA and the taxable amount Box 2a: as being “0”. My question is “do I handle the 1099-R with distribution code “N” in exactly the same manner as other 1099’s?” I guess the taxable amount being “0” is what throws me.
Permalink Submitted by Alan Spross on Thu, 2009-01-15 06:36
The N coded 1099R reflects the recharacterization of both conversions and essentially erases the need to report the conversions on Form 8606. However, the IRS wants an explanatory statement submitted with the return explaining these transactions. That would read something like this:
“On xx/xx/2008 I converted $X to my Roth IRA and on yy/yy/2008 I converted $y to my Roth IRA. On zz/zz/2008 I fully recharacterized both conversions back to my TIRA the value of both conversions then being (show amount on N coded 1099R here).
There is no tax due because you reversed both conversions. Assuming that both the conversions and recharacterizations were done in 2008, add up to total amount on all the 1099Rs and show it only on line 15a of Form 1040. Nothing goes on 15b because none of this is taxable.
Permalink Submitted by Herm Brames on Wed, 2009-02-04 02:33
Alan, as a footnote to my earlier posts concerning the recharacterization put-back number on my ROTH, I am pleased to report that today I received a call from the Vanguard Retail Resolution Services Office indicating that Vanguard will go with my lower put-back amount of $30,128.02 as vrs. their number of $45,535.91 if I send Vanguard a letter taking responsibility for the calculation and addditionally state that I hold Vanguard harmless from any adverse tax consequenses arising from that recharacterized ROTH IRA.
After my last post to you I communicated by letter to Vanguard in somewhat similiar language as my lengthy post to you of 13 Jan 2009. The Vanguard rep told me today that they understand that the Treasury Regulation language can be interpreted differently by others and that in my case it was clear that I was adversely impacted by the initial method of aggregation of all ROTHS including those in different accounts in the recharacterization computations and hence the willingness to go with my number if I hold them harmless. I was told that a revised Form 1099-R would be sent upon receiving my letter.
Thanks for all your good counsel Alan.
Permalink Submitted by Alan Spross on Wed, 2009-02-04 02:55
Good news. Persistance really paid off for you in this situation.
Thanks for posting your results. I hope Vanguard can make any changes to their policy or their account platforms as the case may be to eliminate these problems since very few taxpayers would know the difference or take the time to investigate.
Permalink Submitted by James Mitchell on Thu, 2009-02-05 05:09
Here’s another VG story. I converted from three different VG TIRA funds last year into similar funds in my single VG Roth. Near the end of 2008, I re-characterized all of one of the fund conversions and now, in 2009, I plan to re-characterize part of one of the other conversions. The first one was done without any big surprises and I’m not too worried about the second.
For this year’s conversions, however, I wanted to be more careful so I called VG today and asked if it would be better for me to set up a second Roth to convert into. At first, I was told the Roths would all be considered as one. After asking to talk with someone in their IRA group, I was told that VG was reviewing this process and that quite probably a second Roth could be treated independently for purposes of re-characterization. She did say that this would probably trigger an IRS audit and that I should consult a tax expert.
I’m a do-it-yourselfer, use Turbotax, and don’t have access to a tax expert. I’m just going to set up the second Roth and see what happens.
James
Permalink Submitted by Alan Spross on Thu, 2009-02-05 19:27
Go ahead and request a new Roth for each future conversions. No downside to it, and there would be an upside if Vanguard gets their procedures and account platforms in order to treat the accounts separately.
With respect to triggering an audit, there is nothing about a normal conversion and recharacterization that will trigger an audit, but if Vanguard reports earnings calculations or issues an abnormal 1099R and 5498, THEY could be the source of increased audit risk. Therefore, it is difficult to handicap this risk without knowing how Vanguard plans to handle these transactions.
I have speculated before that Vanguard knows very well what the IRS Regs say, but they have an account platform that uses a single sweep account for more than one Roth IRA, and therefore forces them to combine the Roths for earnings calculations. Hopefully, all the recharacterization activity this year will motivate them to solve this.