Roth Conversion/Recharacterization Questions

Submitted by Seth Poppel on Wed, 2013-01-02 14:38

I will try and make my situation as simple (numerically) as possible and appreciate help:

I am 68 years old and will be 69 on 3/15/2013.

I would like to TRY converting my conventional IRA (all pre-tax contributions) to a Roth on January 10, 2013 and
seeing what happens with that through October 10 of 2014, since I can recharacterize through my extended
tax filing date.

I have about $3mm in 2 conventional IRAs and would convert $2mm as an example.

I think I understand the “mechanics” with regard to working with my trustee (Schwab) to execute this and
already have a Roth (which I “cleaned out” in December 2012 so it has ZERO in it and thus I will not be
comingling any of the converted funds with any existing Roth funds.)

Here are my questions:
a.) If, on October 10, 2014 the value of the converted account has risen to $3mm from the original $2mm and I elect to NOT recharacterize…Do I pay tax on the $2mm that I originally converted or the $3mm that this amount has grown into??
b.) If, on October 10, 2014 the value of the converted account is $2.4mm, or $2mm or 1.5mm and I elect to recharacterize, I assume I return ALL of the money (whether it is $2.4, $2 or $1.5) and that NO tax is due.
c.) Since my RMD from a conventional IRA must be taken (complicating factor) as I will be 70.5 on September 15, 2014…when do I do that calculation? If it is at year-end of 2014, all is good as I will know what my conventional IRA balance will be since I will know if I have recharacterized or not by then and can compute it on the proper amount.
d.) Since I am over 59.5, if I do NOT recharacterize and keep the conversion to the Roth after October 15, 2014, are there ANY restrictions on my withdrawing funds from the Roth (in other words if I am successful at growing my $2mm into $3mm, can I then withdraw the $750-$800,000 that will be due for my taxes from that Roth at that time??

Thank you, much appreciated.



Submitted by Alan - IRA critic on Wed, 2013-01-02 23:00

  1. a) You are only taxed on the 2mm you converted in 2013. You are not taxed on the gains unless you withdraw the gains before 5 years have passed from the year of your first Roth IRA contribution.
  2. b) Correct. You can also do partial recharacterizations. For example, if you recharacterized 40% of your conversion, then 40% of the Roth would transfer to a TIRA and you would be taxed on $1.2mm instead of $2mm.
  3. c) Your 2014 RMD is based on your 12/31/2013 balance. That balance has been reduced because of your conversion. If you recharacterize the conversion after 12/31/2013, you will have to add the amount that transfers back to the TIRA to your actual 12/31/2013 TIRA balance. Obviously, that will increase your RMD. See p 32 of Pub 590, “Outstanding Rollovers and recharacterizations”.
  4. d) No restrictions apply. The 5 year holding period for conversions does not apply after age 59.5. As noted above, if your first Roth contribution was prior to 2009, your Roth is now fully qualified and even earnings would be tax free.


Submitted by Seth Poppel on Thu, 2013-01-03 03:40

First and foremost let me express my appreciation for your expertise and the succinct and clear way you respond to questions!  Both are greatly appreciated.  Please allow me to ask a few follow-up questions.1.)  I will turn 70 on March 15 of 2014  …. You indicate that I need to do the calculations on my 12/31/2013 balance?  When do I actually TAKE the distribution and on what year’s tax return is it reported? 2.) Another complicated question: If I file my tax extension in my prior example on April 15, 2014, I would assume if I have “converted” $2,000,000 that I would need to send in a large check (i.e. $700-$800,000) with that extension request, as I assume that the “safe harbor” only would apply for estimated payments applied to the 2014 return UP UNTIL THAT TIME? OR…would sending in 110% of my prior year’s taxes (those paid in 2013 for 2012) cover me.  AND follow on to that..3.) If I do have to send in $700,000-$800,000 on April 15, 2014 can I withdraw it at that time from the converted IRA (now a Roth)?  (I realize that if I do it could change all of the options for me on October 15).Again, thank you!



Submitted by Alan - IRA critic on Thu, 2013-01-03 05:40

  1. 1) You would take your first year RMD anytime in 2014 or as late as 4/1/2015. This is a special rule that only applies to your first year RMD. If you delay that RMD you will have to take 2 RMDs in 2015. It is reported and taxable in whatever year you choose to take the distribution. Generally, you would want to equalize your taxable income in each year, so that would indicate taking the 2014 RMD by the end of 2014.
  2. Actually, if you meet a safe harbor in 2013 by paying quarterly estimates or withholding equal to your 2012 tax liability, you will not incur an underpayment penalty for the 2013 conversion, but there would be a large amount due on 4/15/2014. The 2014 return is the one that requires managed estimates if your RMD rises for 2014 because you recharacterized some of the 2013 conversion. However, if you do not recharacterize the conversion, your 2014 taxes would be much lower and you would probably try to use 90% of the actual 2014 tax liability for 2014 estimates instead of paying in based on the large 2013 tax liability.
  3. You could take a Roth distribution to pay 2014 taxes if necessary, eg you might take 4 distributions to pay 4 equal estimates, but when you are working with 90% of the current year tax liability you won’t know exactly what that will be. But if you fall short, late interest rate is only 3%. If you withdraw too much from the Roth to pay taxes, you won’t have enough left to complete a recharacterization. You probably need to move up your decision dates on the recharacterization to eliminate potential problems.


Submitted by Seth Poppel on Thu, 2013-01-03 08:39

Again, prompt and well articulated responses from both of you and much appreciated.Seth



Submitted by Seth Poppel on Thu, 2013-01-03 08:48

1.) Just to clarify…If I convert on January 10, 2013, follow safe harbor on estimated taxes, and DO NOT pay anything additional with my April 15, 2014 extension….then come to October 15, 2014 and decide to NOT recharacterize (and thus owe e.g. $750,000) I would incur no penalty and only pay 3% interest on the $750,000 (from April 15-October 15?) and that is it?? 2.) If I DO recharacterize on October 15,2004 can I try another conversion starting in January 2015, with an ultimate deadline of October 15, 2016? Thank you!!



Submitted by mk foss on Thu, 2013-01-03 05:55

1. If you turn 70 in March 2014, your first RMD must be taken sometime between January 1, 2014 and April 1, 2015. The second RMD must be taken between January 1 and December 31, 2015. To avoid taking two RMDs in one year most people take the first RMD in the year they attain age 70-1/2.2. You are supposed to have paid in at least 90% of your ultimate tax with an extension request. The 100/110% rule applies only to avoid estimated tax penalties.3. You can withdraw from the Roth to pay your taxes due on the conversion.



Submitted by Alan - IRA critic on Thu, 2013-01-03 16:41

If you recharacterize a 2013 conversion in Oct, 2014, you can reconvert that amount 30 days after the recharacterization is processed. If the original conversion was in 2014, then you would have to wait to Jan, 2015 to reconvert an October recharacterized amount. Note that if you convert such a large amount in a single year, you will now be subject to the 39.6% federal rate plus phased out exemptions and deductions under the new tax legislation. It may be wiser to just convert incremental amounts (after taking out RMD starting with first RMD year) that will not inflate your tax bracket. There are other strategies to consider as well, such as doing more than one conversion using different Roth accounts that are invested in assets that move differently. Then you can retain the best performer and recharacterize the other.



Submitted by Seth Poppel on Thu, 2013-01-03 19:22

Just to clarify…If I convert on January 10, 2013, follow safe harbor on estimated taxes, and DO NOT pay anything additional with my April 15, 2014 extension….then come to October 15, 2014 and decide to NOT recharacterize (and thus owe e.g. $750,000) I would incur no penalty and only pay 3% interest on the $750,000 (from April 15-October 15?) and that is it??   Again, thank you!P.S. For a variety of reasons I will be in the highest marginal bracket anyway….so that is not an issue, but the idea of splitting with a strategy that invests in “opposite” directions (insuring one has good gains) is a very clever thought.



Submitted by Alan - IRA critic on Thu, 2013-01-03 20:44

  • The 3% interest is just one is one part and the other part is the late payment penalty of 1/2% per month. Times 6 months that equals 3% of the amount due. The first part is 3% annual rate, so would be 1.5% for 6 months. Totals up to 4.5% as I interpret the following copied from IRS site:
  • Underestimate and late payment penalties.Taxpayers are required to have withholding of tax or make quarterly estimated tax payments before the end of the tax year. Since accurate estimation requires accurate prediction of the future, taxpayers may underestimate the amount due. The penalty for paying too little estimated tax or having too little tax withheld is computed like interest on the amount that should have been but was not paid.[2] For 2009, this interest rate was 4%.Where a taxpayer has filed an income or excise tax return that shows a balance due but does not pay that balance by the due date of the return (without extensions), a different charge applies. This charge has two components, first an interest charge, computed as described above, and second a penalty of 0.5% per month applied to the unpaid balance of tax and interest.[3] The 0.5% penalty is capped at 25% of the total unpaid tax.The underestimate penalty and interest on late payment are automatically assessed. No reasonable cause exception applies for these penalties.[4]


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