Saturday, August 27, 2011

Roth Recharacterizations Highlight Mailbag

Roth conversions and recharacterizations can be complicated, as illustrated by the question below. We tackle that situation in this week's Slott Report Mailbag. As always, we stress the importance of working with a competent, educated financial advisor to keep your retirement nest egg safe and secure. Find out at this link..


Thanks for all the good information in the Slott Report.

I have a question on recharacterization and later conversion to Roth (of recharacterized assets - stock).

I understand the recharacterization (and conversion) rules to be:

     1. Conversion to Roth cannot be done until RMD has been taken for that year.

     2. IRA owner can recharacterize as long as it's done before filing tax return (which can be put off  until October)

3. Recharacterized assets cannot be converted to Roth again for 30 days.

4. Recharacterized assets cannot be converted to Roth again in the same (tax) year that they were initially converted.

I had to wait until 2010 to convert, when the income limits were removed.

January 2010

a. took my RMD based on traditional IRA YE 2009 value

b. after taking RMD, converted some stocks to Roth (R1)

June 2010

c. converted some more stocks to Roth (R2)

September 2010 - filed my 2009 income tax return. Not affected by 2010 Roth conversions.

January 2011

d. took RMD based on traditional IRA YE 2010 value. (Roths excluded from value).

February 2011

e. converted some more to Roth (R3)

June 2011

f. stocks R2 of (c) have tanked

How do I avoid IRS problems?

I'd like to recharacterize R2, since the stock is worth 20 percent of its value when I converted it to Roth.

Can I recharacterize R3 (Feb 2011), and then take an additional 'delta' RMD to account for the value of R2 at year-end 2010? Would this then enable me to recharacterize R2? (If I did this, I'd have to wait until 2012 to convert R3 to Roth again.)

Or am I caught and must maintain my R2 Roth conversion from June 2010, paying the very high conversion tax even though the stock has tanked?

If I did recharacterize R3, will the IRS still say that the RMD paid in January cannot be increased by this approach?

Kind regards,

George Bumiller

Wow, did you follow all of that. Great question.

The answers to your various questions are as follows:

You are correct in that RMDs must come out first before converting to a Roth IRA.

You have up to 10/15 of the following year to recharacterize. Your tax must be timely paid and your return timely filed or on extension in order to qualify for that deadline. However, if you already filed your tax return you will have to file an amended return on Form 1040X. You have three years from the original due date (or extended due date) of your return to file your amended tax return. The recharacterization though still must be completed no later than 10/15 of the year following the conversion.

The rule states than once you convert and then recharacterize, you cannot reconvert those same funds until the year after the year of the conversion or more than 30 days after the recharacterization, whichever is later.

For your June 2010 conversion to Roth 2 you have until 10/15/2011 to recharacterize those funds and you can reconvert after 30 days.

For your Feb. 2011 conversion to Roth 3 you have until 10/15/2012 to recharacterize those funds and you cannot reconvert until 2012.

Since you are taking RMDs, the prior year-end account value of the Roth IRA will have to be added to the prior year-end account value of the traditional IRA that ends up with the recharacterized funds in order to correctly calculate your RMD for the traditional IRA after the recharacterization is done.

Example: You recharacterize the full amount in R2 in 2011. The 12/31/2010 year-end account value in R2 is $20,000. You have to include the $20,000 in your RMD calculation for the traditional IRA in 2011.

Since your situation is somewhat complicated and you seem to have many questions, you should consult with a tax advisor with experience in this area as to the correct procedures you need to follow.


What is the most effective way in managing, accounting and subsequently taking distributions from a rollover IRA that contains post-tax contributions?

Details: Age 63, just retired and rollover various retirement accounts(401(K), 403(B), 457) to a single rollover IRA. The post-tax contributions were part of the 457, which the funds are now in a rollover IRA.

Thanks in advance.


Because you have both pre- and after-tax dollars in the IRA rollover, you will track the after-tax amount on Form 8606, which you will file with your tax return. You are required to file the form for any year in which you make a contribution of after-tax amounts to your IRA and for any year in which you take a distribution from any IRA, including SEP and SIMPLE IRAs. You will have to use the pro-rata rule for your distributions, which states that each dollar withdrawn from the IRA will contain a percentage of tax-free and taxable funds based on the percentage of after-tax funds to the entire balance in all your IRAs.

By Marvin Rotenberg and Jared Trexler
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