IRA Recharacterization when other contributions *were* made

[bortery]

In March of 2012, I contributed $5,000 to a non-deductible Traditional IRA. A few days after, I converted it to a Roth IRA.

Throughout the year, I made contributions to the Roth IRA by way of putting money into my company's after-tax 401(k) plan* and rolling it over into the very same Roth IRA.

Now I am looking to "undo" the $5,000 I converted from Traditional IRA to Roth IRA. My question is: How do I calculate the amount of money I have to recharacterize in order to do this?

I am basically in the exact same situation that this IRS site gives an example of, except that it says *no* other contributions were made to the Roth IRA, whereas I did in fact make further contributions (Under the "Determining the Amount of Net Income Due To an IRA Contribution and Total Amount To Be Recharacterized" section):

http://www.irs.gov/publications/p590/ch01.html#en_US_2012_publink1000230671

I'd love for there to be a line in this calculation that asks how much money in the closing balance of the Roth IRA was *not* due to the conversion, but I can't find it anywhere.

Any help is greatly appreciated as I have not been able to find any examples where further contributions were made.

Thanks in advance!

*This appears to be fairly uncommon for companies to offer, since many people I have talked to have not heard of it, so apologies if this is something you're unfamiliar with.

[Alan S.]

Typically, the Roth custodian will do the calculation. But if you want to determine the earnings allocation (NIA) yourself before requesting the recharacterization, the other rollover contributions you made to the Roth during the time your conversion was in the Roth are simply added to your opening balance as an adjustment, and the closing balance is the actual closing balance without adjustments. Here is a more user friendly explanation of the formula that should be used by the Roth custodian:

http://www.retirementdictionary.com/def ... butablenia

Why do you want to recharacterize the conversion. Did it turn out to be taxable?

[bortery]

Typically, the Roth custodian will do the calculation. But if you want to determine the earnings allocation (NIA) yourself before requesting the recharacterization, the other rollover contributions you made to the Roth during the time your conversion was in the Roth are simply added to your opening balance as an adjustment, and the closing balance is the actual closing balance without adjustments. Here is a more user friendly explanation of the formula that should be used by the Roth custodian:

http://www.retirementdictionary.com/def ... butablenia

Why do you want to recharacterize the conversion. Did it turn out to be taxable?

Alan,

Thank you so much for your answer. I had not been able to find this anywhere, and even a few CPAs were unfamiliar with what I was trying to do. I do have a follow-up question:

So if I add the other rollover contributions that were made to the Roth during the time the conversion was in the Roth to the Adjusted Opening Balance, do I also have to take into account any earnings that money gained in the Roth? In other words, if I made $10,000 in rollover contributions, do I add $10,000 to the Adjusted Opening Balance, or do I need to figure how much that $10,000 gained and add that (e.g. if it gained $500, would I then have to add $10,500 to the opening balance)?

I also have one more general recharacterization question for you: Once I do this recharacterization, I believe that when I file my taxes that are due this April, I will treat the money that was recharacterized as if it were only ever contributed to the Traditional IRA in 2012. This amount will be ~$15,000 + gains made while in the Roth (in my original post I said $5,000 in order to keep things simple, but in March of 2012 I actually converted Traditional IRA contributions from 2010, 2011, and 2012). This $15,000 + gains is obviously more than one is allowed to contribute to a Traditional IRA in one year. Will the IRS be okay with this, and will TurboTax allow it? From what I've read for recharacterizations, I should include a note with my tax return explaining that I recharacterized that $15,000 + gains and will report the recharacterization on my taxes due in April of 2014.

The reason I want to do the recharacterization is rather a long story, but since you asked... . Since I am over the income limit to contribute directly to a Roth IRA, I want to do a back-door Roth. I found out about this last year and decided to convert my Traditional IRA contributions for 2010, 2011, and 2012 to Roth all at once. Then in January of this year, I found out that because I had a Rollover IRA of around $57,000, the government will not let me pick and choose which non-Roth money to convert. Therefore, I'd be taxed on ~$12,000 of the conversion (because 57,000 / (57,000 + 15,000) = ~80%, and 80% of $15,000 is ~$12,000). If I had to pay taxes on that much money this year, I would probably be assessed a penalty, because I owed quite a bit in taxes last year due to a one-time income increase that was taxed at too low of a percentage.

So to answer your question, I am recharacterizing to avoid a second large tax bill two years in a row.

My plan going forward is to do this recharacterization. A few days after that, I will roll over my Rollover IRA into my company's pre-tax 401(k) plan (they allow this). This should give me a zero cost-basis for converting Traditional IRA money to Roth IRA money. After the 30 day waiting period following the recharacterization, I will then *reconvert* that ~$15,000 back to the Roth IRA. I will then be able to continue doing back-door Roths without this huge hassle .

Please let me know if this sounds crazy and ill-advised, but my research has led me to believe this path will work.

[Epsilon Delta]

So if I add the other rollover contributions that were made to the Roth during the time the conversion was in the Roth to the Adjusted Opening Balance, do I also have to take into account any earnings that money gained in the Roth? In other words, if I made $10,000 in rollover contributions, do I add $10,000 to the Adjusted Opening Balance, or do I need to figure how much that $10,000 gained and add that (e.g. if it gained $500, would I then have to add $10,500 to the opening balance)?

You add the actual value of the contriibution with no adjustment. It's a horrible, inelegant, approximation to economic reality; but that's what the IRS says to do. So don't think too hard, just follow the instructions.

http://www.irs.gov/pub/irs-drop/n-00-39.pdf

[Alan S.]

OK - your overall plan will work as long as you can roll your rollover IRA into your current plan before the end of 2013.

1) The earnings on your recharacterization of the 2012 conversion will be determined by the formula. The formula reflects the earnings generated on all assets in your Roth during the accumulation period of the conversion to be recharacterized. By adding these other Roth rollovers, the earnings % will usually be diluted since the other contributions had less time to generate earnings. However, any combination of results is possible because the formula is a simplifed approach rather than a totally equitable number. You might want to determine the amount of earnings to be transferred back to your TIRA before ordering the recharacterization. The larger the amount, the less attractive recharacterization is because you will be moving potentially tax free earnings into a pre tax IRA.

2) Your taxable amount of 12k on the 15k conversion is correct if you followed the Form 8606 conversion taxation instructions.

3) The amount you would ideally roll into your current 401k plan is your total TIRA value less your basis from non deductible contributions. You indicated 15k was your total basis. If your rollover IRA value is much less than your total TIRA value less 15k, you should roll the difference into the rollover IRA before doing the transfer, since that will make your conversion of the 15k totally tax free. Otherwise you would pay tax on the amount remaining in your IRA in excess of 15k. For a couple thousand, it's probably not worth doing this adjustment, and you also must be sure that your plan does NOT restrict incoming rollovers to only a rollover IRA as you would not want to mess with the rollover IRA and endanger acceptance by your current 401k.

4) Re 2012 and prior tax reporting - be sure you reported each of those prior non deductible contributions on Form 8606 for the years made, as that is how basis must be documented with the IRS. Your 2012 8606 will show your 2012 non deductible contribution in Part I, and add your prior 10k of basis to get your total basis of 15k. The 8606 will NOT show your TIRA conversion if you recharacterize it, and it will not show your rollover of after tax 401k contributions either because they came directly from a non IRA plan. Do NOT confuse your conversion of 15k with the REGULAR IRA Contribution limit, as there is no limit to your conversion amount. The end result in the forms view for Ttax would be that line 16a would show your gross rollover from the after tax 401k contributions and 16b would show the taxable amount in Box 2a of the 1099R. 2a includes earnings on your contributions before you did the rollovers to your Roth. Line 15 will not have an entry if you recharacterize the 15k conversion, but you should add an explanatory statement to your return (Ttax has a screen to enter this) indicating the date and amount of your 15k conversion, and the date and amount of your conversion that was recharacterized, and also the value that transferred to the TIRA. You will get this info from your IRA activity statements after the recharacterization is done. With a correct statement, you will not refer to your recharacterization again on your 2013 return because your 1099R for the recharacterization will be coded to apply to 2012, not 2013.

5) There are some other threads here that cover what you need to enter into TTax to get the above result correct. It can be tricky, so it's good to know what your 8606 and 1040 should look like after your input.

[Default User BR]

I went through this years ago at Wells Fargo. I just filled out the recharacterization form, then they calculated the share of earnings and asked me which funds to move over to the TIRA. I attached a written explanation of what happened to my tax forms. The IRS did not ask me any questions about it. As a "bonus" 2008-2009 happened, so when I went to convert it again I could keep more of the formerly taxable amount to put in the Roth.


Brian

[bortery]

OK - your overall plan will work as long as you can roll your rollover IRA into your current plan before the end of 2013.

1) The earnings on your recharacterization of the 2012 conversion will be determined by the formula. The formula reflects the earnings generated on all assets in your Roth during the accumulation period of the conversion to be recharacterized. By adding these other Roth rollovers, the earnings % will usually be diluted since the other contributions had less time to generate earnings. However, any combination of results is possible because the formula is a simplifed approach rather than a totally equitable number. You might want to determine the amount of earnings to be transferred back to your TIRA before ordering the recharacterization. The larger the amount, the less attractive recharacterization is because you will be moving potentially tax free earnings into a pre tax IRA.

Thanks again for the reply. Yes, I ran through the calculation (this time taking into account the rollover contributions in the Adjusted Opening Balance) and it came out to around $18,500 or so, so the gains are about $3,500. Not too large to discourage me from moving forward with the recharacterization. Without taking the rollver contributions into account in the Adjusted Opening Balance, that number was *significantly* higher.

2) Your taxable amount of 12k on the 15k conversion is correct if you followed the Form 8606 conversion taxation instructions.

Great, thanks!

3) The amount you would ideally roll into your current 401k plan is your total TIRA value less your basis from non deductible contributions. You indicated 15k was your total basis. If your rollover IRA value is much less than your total TIRA value less 15k, you should roll the difference into the rollover IRA before doing the transfer, since that will make your conversion of the 15k totally tax free. Otherwise you would pay tax on the amount remaining in your IRA in excess of 15k. For a couple thousand, it's probably not worth doing this adjustment, and you also must be sure that your plan does NOT restrict incoming rollovers to only a rollover IRA as you would not want to mess with the rollover IRA and endanger acceptance by your current 401k.

I'm a bit confused here, but I maybe did not give you enough information. In March 2012, Vanguard showed an account for a Rollover IRA worth $57,000 and a TIRA account of ~$15,000 (that's money from TIRA non-deductible contributions in 2010, 2011, and 2012, plus minimal gains that were made). I then converted all of the money in the TIRA account to Roth IRA. So in April 2012, Vanguard showed an account for a Rollover IRA worth $57k, and a TIRA account of $0 (this is still at $0 today). The rest of the year I started doing the rollover contributions directly into Roth IRA from the after-tax 401(k).

I now want to recharacterize the $15,000 (which, as noted above, will actually be a recharacterization of $18,500) so that my TIRA account will contain $18,500. Then I will roll over the Rollover IRA (the $57,000) into my company's pre-tax 401(k), and after 30 days from my recharacterization, reconvert the $18,500 in the TIRA account into Roth IRA. This will leave my Rollover IRA *and* my TIRA account with a balance of $0.

In the quote above, you say it would be ideal to roll over my total TIRA value less my basis from non deductible contributions into my company's pre-tax 401k. Does the "total TIRA value" you'e referring to contain the Rollover IRA + the current value of my TIRA? If so, that is $57k + $0k.

From your question, I am wondering if I accidentally led you to believe that the specific TIRA account (as opposed to the Rollover IRA account) was not $0. It is $0.

4) Re 2012 and prior tax reporting - be sure you reported each of those prior non deductible contributions on Form 8606 for the years made, as that is how basis must be documented with the IRS. Your 2012 8606 will show your 2012 non deductible contribution in Part I, and add your prior 10k of basis to get your total basis of 15k. The 8606 will NOT show your TIRA conversion if you recharacterize it, and it will not show your rollover of after tax 401k contributions either because they came directly from a non IRA plan. Do NOT confuse your conversion of 15k with the REGULAR IRA Contribution limit, as there is no limit to your conversion amount. The end result in the forms view for Ttax would be that line 16a would show your gross rollover from the after tax 401k contributions and 16b would show the taxable amount in Box 2a of the 1099R. 2a includes earnings on your contributions before you did the rollovers to your Roth. Line 15 will not have an entry if you recharacterize the 15k conversion, but you should add an explanatory statement to your return (Ttax has a screen to enter this) indicating the date and amount of your 15k conversion, and the date and amount of your conversion that was recharacterized, and also the value that transferred to the TIRA. You will get this info from your IRA activity statements after the recharacterization is done. With a correct statement, you will not refer to your recharacterization again on your 2013 return because your 1099R for the recharacterization will be coded to apply to 2012, not 2013.

I just checked my past tax returns, and I have indeed reported each of the prior non-deductible contributions on Form 8606. I understand now what you mean about the difference between conversion and contribution limit, but what I am still not clear on is when I should pay taxes for the earnings that the conversion made while in the Roth (i.e. of the $18,500 that I will recharacterize, $3,500 is gains). You mention that "Your 2012 8606 will show your 2012 non deductible contribution in Part I." I assume I will just put $5k there? I will of course explain in a note the numbers that you suggest, but doesn't that $3,500 have to be reported on either my 2012 or 2013 taxes? I ask because you say that for my 2013 taxes, I won't have to reference the recharacterization again. When Vanguard sends me a 1099R in January 2014 for the recharacterization, I should just keep that for my records and not mention the recharacterization for the taxes due April 2014? When do I pay taxes on the $3,500?

5) There are some other threads here that cover what you need to enter into TTax to get the above result correct. It can be tricky, so it's good to know what your 8606 and 1040 should look like after your input.

I will try to dig up these threads.

Thanks again for your time!

[bortery]

Sorry for the bump, but I think my post got a little buried. Did Alan or anyone else have any thoughts on my last few questions? Thanks to all who have replied thus far!

[Alan S.]

Some of the confusion might arise from my reference to the TIRA as including the rollover IRA. A rollover IRA is a TIRA in all respects other than being earmarked as coming originally from an employer plan.

When you recharacterize the 15k conversion, the earnings of 3,500 will also transfer back to the TIRA. That will give you a total TIRA pre tax balance of 57k plus 3.5k. If you roll only the 57k into your 401k plan, when you convert the remaining 18.5k, 3.5k will be taxed. You can avoid the 3.5k being taxed if you include it in your rollover to the 401k. since only the 15k of basis will be left and you could convert that tax free.

The caution flag that makes this a little more complex is that IF you 401k plan only accepted "rollover IRAs", you could not first transfer the 3.5 of earnings into the rollover IRA since it would no longer be a rollover IRA due to the commingling, and then the plan might not accept any part of your IRA. If you want to avoid this issue, you could roll just the 57k to the 401k and pay conversion tax on 3.5 of the 18.5.

Yes, you would enter 5k on line 1 of your 2012 8606, 10k on line 2 and line 3 would total your basis at 15k. The 3.5k is only referenced in your explanatory statement when you indicate that you recharacterized the 15k conversion and it was worth 18.5 when the recharacterization was done. The 3.5 will be the taxable part of your 2013 conversion (unless as explained above you roll it to the 401k along with the 57k). You would pay tax on the 3.5 in the year of conversion (2013) otherwise. You will get a 1099R for that in Jan, 2014. You will also get a recharacterization 1099R in Jan, 2014 and that is the one you can ignore as long as it agrees with the explanatory statement you made with your 2012 return. You would just keep that 1099R with your 2012 tax records since it pertains to 2012.

NOTE: Not discussed before, but in 2013 you plan on rolling either 57k or 60.5k into your 401k plan. You will have to include an explanatory statement about that with your 2013 return. Therefore your 2013 return would only include the rollover to the 401k on line 15a and 15b with the explanatory statement), and an 8606 to report your 2013 non deductible contribution in Part I and your conversion in Parts I and II.

[bortery]

Ah, yes, this clears things up. Because Vanguard lists out my accounts as: "Rollover IRA, Traditional IRA, and Roth IRA," I always refer to all three separately. But yes, the rollover IRA actually being a traditional IRA makes sense.

And now I understand what you were saying about rolling the $3.5k into the 401k. My plan is to just keep it in the TIRA after recharacterization and pay tax on it since that number isn't too large.

A few last questions for you:

1. In a previous post in this thread discussing reporting my 2012 taxes, you say "Line 15 will not have an entry if you recharacterize the 15k conversion." Do you just mean nothing from line 15 will be taxable? I took a look at http://www.irs.gov/instructions/i8606/ch01.html#d0e470, and under the first example in "Reporting recharacterizations" it says (I shortened it a bit):

"You converted an amount from a traditional, SEP, or SIMPLE IRA to a Roth IRA in 2012 and later recharacterized all or part of the amount back to a traditional, SEP, or SIMPLE IRA. If you recharacterized the entire amount, do not report the recharacterization on Form 8606. Attach a statement to your return explaining the recharacterization and include the amount converted from the traditional, SEP, or SIMPLE IRA in the total on Form 1040, line 15a; Form 1040A, line 11a; or Form 1040NR, line 16a."

What it doesn't say is that 15b should be left blank (I assume), so tax owed will be zero. Is that correct, or were you referring to something else that I'm missing?

2. In your last post you said, "In 2013 you plan on rolling either 57k or 60.5k into your 401k plan. You will have to include an explanatory statement about that with your 2013 return." What is the note for? Is this a taxable event? I am rolling over a pre-tax rollover IRA into a pre-tax 401k. Will there be forms generated that Vanguard will send me that I would have to report on tax filings in the future?

3. I understand that I can ignore the 1099R regarding the recharacterization that I will receive in Jan, 2014. I received a 1099R in Jan, 2013 about the conversion from TIRA to Roth that took place in 2012, but since I'm recharacterizing, I can ignore that sheet completely, yes? So the only thing I am ever filing with my taxes in regard to the recharacterization is the explanatory note on my 2012 taxes? Just want to confirm.

4. In your last post you said "Therefore your 2013 return would only include the rollover to the 401k on line 15a and 15b with the explanatory statement), and an 8606 to report your 2013 non deductible contribution in Part I and your conversion in Parts I and II." I just want to confirm that the part about the 8606 comes from your assumption that I will contribute to a TIRA and convert it to Roth in 2013 (this is in addition to the $18.5k resulting from the recharacterization that I will convert to Roth in 2013). You would be correct, I just want to make sure that's what you were getting at .

Thanks again!

[Alan S.]

1) Good point. I should have clarified that line 15a should show the converted amount, but NOT 15b if you recharacterized the full conversion (per Form 8606 Inst).

2) The explanatory statement regarding the 2013 rollover of your pre tax TIRA balance to your 401k plan will provide assurance to the IRS that you actually did roll the amount to the 401k. You and the IRS will get a 1099R from VG for that rollover which is reported on line 15a and 0 on 15b with "rollover" entered next to 15b. However, unlike an IRA to IRA transfer, there is NO Form 5498 issued by the 401k plan and therefore nothing for the IRS to match up the 1099R to assure them you you did not cash out the money. This has resulted in alot of IRS inquiries, and the only way to minimize your chance of such as inquiry is to make a clear explanatory statement with your 2013 return that you DID roll the amount into your 401k plan. This should only be a one year reporting event since you will not be rolling funds into your 401k very frequently.

3) As noted in 1) above, you should still enter the converted amount that you recharacterized on line 15a only. Other than that all you need is the explanatory statement regarding the conversion and recharacterization. No 8606 is needed since you are recharacterizing the entire conversion.

4) Yes, that is correct. You will need the 8606 to report the 2013 conversion anyway, but will only report a 2013 non deductible contribution on the 8606 if you decide to make one.

NOTE: If you continue to make after tax contributions to your 401k and convert them, you will also get a 1099R for that. These go on line 16a and 16b rather than 15 (15 is for distributions FROM IRAs and 16 is for distributions from non IRA plans). For 2013, you will have at least TWO figures to add up on line 15 - first the rollover from your IRA to the 401k, and second the conversion of the remainder of your IRA to your Roth IRA.

[bortery]

So if I add the other rollover contributions that were made to the Roth during the time the conversion was in the Roth to the Adjusted Opening Balance, do I also have to take into account any earnings that money gained in the Roth? In other words, if I made $10,000 in rollover contributions, do I add $10,000 to the Adjusted Opening Balance, or do I need to figure how much that $10,000 gained and add that (e.g. if it gained $500, would I then have to add $10,500 to the opening balance)?

You add the actual value of the contriibution with no adjustment. It's a horrible, inelegant, approximation to economic reality; but that's what the IRS says to do. So don't think too hard, just follow the instructions.

http://www.irs.gov/pub/irs-drop/n-00-39.pdf

Thanks very much for this info! It seems like an odd approximation to me as well, but if that's what they want...

[bortery]

I went through this years ago at Wells Fargo. I just filled out the recharacterization form, then they calculated the share of earnings and asked me which funds to move over to the TIRA. I attached a written explanation of what happened to my tax forms. The IRS did not ask me any questions about it. As a "bonus" 2008-2009 happened, so when I went to convert it again I could keep more of the formerly taxable amount to put in the Roth.


Brian

Thanks for this! I just did the recharacterization last week, and it looks like they moved over the correct amount (I pre-calculated what the earnings should approximately be, and it's in that range).

Now it's going to be fun getting TurboTax to let me add that explanatory statement. I know there's a place for it, but from what I've read, TurboTax has a hard time with conversions done in one year, then recharacterizations done the next year BEFORE taxes for last year were filed. I'll probably try to call TT up.

[bortery]

1) Good point. I should have clarified that line 15a should show the converted amount, but NOT 15b if you recharacterized the full conversion (per Form 8606 Inst).

2) The explanatory statement regarding the 2013 rollover of your pre tax TIRA balance to your 401k plan will provide assurance to the IRS that you actually did roll the amount to the 401k. You and the IRS will get a 1099R from VG for that rollover which is reported on line 15a and 0 on 15b with "rollover" entered next to 15b. However, unlike an IRA to IRA transfer, there is NO Form 5498 issued by the 401k plan and therefore nothing for the IRS to match up the 1099R to assure them you you did not cash out the money. This has resulted in alot of IRS inquiries, and the only way to minimize your chance of such as inquiry is to make a clear explanatory statement with your 2013 return that you DID roll the amount into your 401k plan. This should only be a one year reporting event since you will not be rolling funds into your 401k very frequently.

3) As noted in 1) above, you should still enter the converted amount that you recharacterized on line 15a only. Other than that all you need is the explanatory statement regarding the conversion and recharacterization. No 8606 is needed since you are recharacterizing the entire conversion.

4) Yes, that is correct. You will need the 8606 to report the 2013 conversion anyway, but will only report a 2013 non deductible contribution on the 8606 if you decide to make one.

NOTE: If you continue to make after tax contributions to your 401k and convert them, you will also get a 1099R for that. These go on line 16a and 16b rather than 15 (15 is for distributions FROM IRAs and 16 is for distributions from non IRA plans). For 2013, you will have at least TWO figures to add up on line 15 - first the rollover from your IRA to the 401k, and second the conversion of the remainder of your IRA to your Roth IRA.

Thank you so much for all of your help, Alan! I had talked to CPAs who were not even familiar with what to do in my specific situation. Going to enter all this stuff into my taxes this weekend. Here's to hoping it all goes smoothly.