Recharacterization mechanics?
My husband and I each did IRA to Roth conversions in early 2010. These assets were commingled with assets already held in our individual Roth accounts. I understand that to do a recharacterization you must take into account the earnings in the entire account, not just those of the converted assets. This is how the two accounts have fared since then:
1st account Beginning balance in the Roth $75,000 + $175,000 Roth conversion amount Total= $250,000 Current Balance $255,000
2nd account Beginning balance in the Roth $100,000 + $25,000 Roth conversion amount Total= $125,000 Current Balance $120,000
Both accounts are fully invested…there is no cash to work with here. What would be the mechanics of recharacterizing these accounts? Is the process any different if one has a gain and the other a loss? Do proportional shares of all the assets have to be moved over? And, let’s say you decided that you wanted to recharacterize just 50% of the total.
Thanks for your help!
Permalink Submitted by Alan Spross on Wed, 2011-10-05 03:37
You can recharacterize all or part of either conversion, but you only have a negligible loss on one of them of about 2%. Therefore, you must have changed your mind about converting in the first place and the tax liability, even though it would be split over 2 years.
Still, you have several choices, but you have to act very fast now because there are only 8 business days left before the recharacterization deadline of 10/17 (not counting Columbus Day). If you wanted to recharacterize half of the account with the 4% loss, then 12,000 of whatever assets you choose would transfer back to the TIRA. That would leave you with a taxable conversion of 12,500 on this account.
.96 *.50*25,000=12,000
Since values change daily, your recharacterization form should give you the option of selecting which investments you want to transfer (eg you might tell the custodian to use A shares and B shares and if more is needed to fill out the transfer with C shares. Most firms will drill down to even partial shares to get to the exact amount. That gives them the flexibility to process the recharacterization at one time. You do not have to have any cash in the accounts.
I would recharacterize all or part of the 2nd account before the first account since the first conversion has a slight gain, but it sounds like you are just having second thoughts about the tax bill for half the conversion income in 2011 and 2012. If so, you might want to retain the amount that allows you to stay out of a higher tax bracket than what you think you might be paying in retirement.
Permalink Submitted by Kathleen Allan on Thu, 2011-10-06 03:46
Thank you for your reply. I was thinking that a sure way to turn this dismal market around was to recharacterize our Roths now. Isn’t that how it always is? Then my other investment accounts would benefit. If I don’t, then the market will continue down. The worse thing would be to pay the full tax bill now on the conversion only to have the Roth accounts crater further.
Anyway, getting back to the matter at hand… I’m afraid you lost me with the 4% loss when you were originally talking about a 2% loss. And correct me but I thought that a recharacherization had to be figured on the total current account, not just on the conversion amount.
Again thank you for your assistance.
Permalink Submitted by Alan Spross on Thu, 2011-10-06 19:33
Sorry, the loss is 4% on the conversion with the earnings loss. In opening sentence I did not do the actual math, and forgot to go back and correct it to 4%.
Yes, the earnings calculation does have to be figured using the total account change. But your figures included that. The loss of $5,000 occurred in some combination of the original 100,000 in the account and the 25,000 added by the conversion. 5,000/125,000 = 4%. If the 25,000 conversion had been done to a newly created Roth account and then the account dropped to 20,000, then the loss for the conversion would be 20% and recharacterization more compelling.
Permalink Submitted by Kathleen Allan on Sat, 2011-10-08 02:26
Many thanks for your attention and clarification!