Roth Conversion/Recharacterization
For this scenario I have 2 assumptions:
1. Someone does a Roth Conversion this year (2009) and finds out next year they have to recharacterize due to income limitations.
2. In 2009 the stock market starts to rebound.
What happens to the growth in the Roth? (E.G.- Person converts $50,000 to Roth. Market goes up increasing Roth value to $65,000 by 12-31-2009.) I know that the person has to recharacterize the $50,000, but I am getting conflicting information on the growth. Can it stay in a Roth or does it have to be put back in the Traditional IRA?
Permalink Submitted by Anonymous (not verified) on Thu, 2009-02-19 22:16
Any growth must go back to the TIRA based on an IRS required earnings calculation. This calculation includes the investment results of the entire Roth IRA holding the conversion, not just the particular investment held by the conversion dollars. The net result is the same as if the conversion had never been done, ie the gain or loss would have occurred in the TIRA, not in the Roth IRA.
The treatment above applies if the recharacterization is done on a timely basis, ie by the extended due date of the 2009 return, which is 10/15/2010. However, if the recharacterization is not done in time, the rules change and there is NO earnings calculation or recharacterization. However, there IS a 6% excise tax on the excess contribution to the Roth. There have been situations (in the distant past) where the earnings on the conversion were very large, perhaps over 30% or more, and in order to keep the earnings in the Roth, the taxpayer intentionally failed to recharacterize, paid the 6%, and then withdrew the amount of the conversion only. The earnings stayed in the Roth.
With investment losses, however, getting the recharacterization done carries more urgency as you do not have gains that will cover your 6% excise tax.