Cherry picking of recharacterized assets allowed?
On February 19, 2010 I convert TIRA consisting of Stock A worth $50,000 and Stock B worth $50,000 to Roth.
At that point I have $100,000 of 2010 conversion income.
By July 1, 2010 Stock A has increased in value to $90,000 and Stock B has declined to $10,000 (so I still have $100,000 total, no overall gain or loss).
I have my Roth IRA custodian recharacterize/transfer Stock B back to the TIRA.
How much is my “net” 2010 conversion/recharacterization income, $50,000 or $90,000?
Thanks
Permalink Submitted by Alan Spross on Fri, 2010-02-19 22:08
$90,000.
But what you are really doing here is recharacterizing 10,000 of your 100,000 conversion and that is the first thing you tell the Roth custodian. THEN, you specify what assets you want to use to come up with that 10,000. It will take all your shares of B to do that. Or you could instead recharacterize 1/9 of your shares of A, which are also worth 10,000 and you will still be left with a taxable conversion of 90,000.
If you wanted to reduce your taxable conversion to 50,000, you would need to send back ALL your shares of B, and 4/9 of your shares of A to get to 50,000 current value. But if you did that, your remaining Roth would only be worth 50,000. So would the TIRA.
You CAN cherry pick. But to make it more effective you would have converted A and B to separate Roth accounts. That way, after you recharacterized the entire Roth conversion of B, you would be left with a taxable conversion of only 50,000 instead of 90,000. And you would still have Roth total values of 90,000 and TIRA value of 10,000, the same as above for just over half as much tax.
This can become very confusing, but it is simpler to think of this as two step process, first HOW much of your original conversion do you want to recharacterize to reduce your tax bill? Then when you get that amount you can decide from the assets you have in the Roth how much of each should be used to get to the amount you need to recharacterize.
Permalink Submitted by Anonymous (not verified) on Fri, 2010-02-19 22:57
Thanks, Alan, I was afraid the answer was $90,000.
But you’ve mentioned the “solution” would have been to make the conversion into separate Roth IRAs and I want to be clear that if you recharacterize an entire Roth IRA account you wipe out the entire amount of conversion income.
So in my original example if I’d used seperate Roth acocunts and then recharacterized the account with Stock B I would only have $50,000 of conversion income at the end of the day and not $90,000, correct?
Permalink Submitted by Alan Spross on Fri, 2010-02-19 23:12
Yes, that is correct.
Permalink Submitted by John Keiler on Sat, 2010-02-20 17:40
Alan, does this imply for tax reasons that on every conversion of multiple funds and each year of a multiple fund conversions that it is wise to have a separate ROTH account for each fund. Example: I convert 4 funds each in 2007,2008 and 2009. I would have 12 ROTH accounts even though I only recharcterized 2 accounts in 2008 ?
By doing this am I right in saying that none of the other ROTH accounts of 2007,2008,2009 would have any bearing on multiple fund conversions in 2010 if I happened to recharacterized 2 of the 2010 ROTH accounts later this year?
TIA Alan ……………. Jack
Permalink Submitted by Alan Spross on Sat, 2010-02-20 19:29
Jack,
The only Roth accounts that affect the earnings calculation in a recharacterization are those accounts that held the actual conversion dollars being recharacterized. Note that you do not have to carry multiple Roth accounts if you do not want to. And if you do want to set them up for possible recharacterization purposes, you can always combine them after the extended due date has passed.
In your example, it is no longer possible to recharacterize your 2007 and 2008 conversions, so those accounts could be combined. After 10/15/2010 you will not be able to recharacterize 2009 conversions either, and that account could be combined with the others.
You can also convert into a single Roth account if you know that you will not recharacterize because your investments in that account are conservative and will not incur losses. Such things as money market funds, CDs, short term bond funds etc will not drop enough to recharacterize, so if your Roth will just hold these types of investments, there is no need to establish more than one Roth account.
If you use a multiple conversion strategy that includes retaining only your best performing conversion, and recharacterizing the other(s), then it is more important to set up the extra Roth accounts. Although you will pay the same amount of tax either way, recharacterizing the worst one will result in more dollars being in your Roth and less in the TIRA at the end of the process and that is what you want to happen. Of course, if both Roths had very good gains, you might elect to keep them both because your total Roth assets will have risen in relation to your increased tax bill for keeping them both.
But while those gains can be reassuring before the recharacterization deadline, the market could still erase them afterwards. So another strategy might be to retain the conversion, but trade into safer investments by the deadline.