Threshold for [Resetting Roth Conversion]
- archbish99
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- Joined: Fri Jun 10, 2011 6:02 pm
Threshold for [Resetting Roth Conversion]
This will be the second year in an account I'm managing where I'll do a Roth conversion up to the top of the 15% bracket. The first year worked out quite well -- estimated the amount to convert, and then as part of tax prep recharacterized the amount that was into the 25% bracket.
This year, I converted just before the much larger dip that has happened over the last week. I know I can do another conversion of the same amount, then recharacterize the entire first conversion (plus however much of the second is needed to stay in the 15% bracket). However, more conversions and recharacterizations, presumably more hassle (and more odds of the IRS wanting to double-check someone's math, though that's a lesser concern). Of course, this whole strategy involves "calling a bottom" to some extent.
For people who use or have considered this strategy, what's your threshold? How do you decide that the market is "enough" lower than a previous conversion that a new conversion makes sense? I can envision the pathological case of doing another conversion every day the market is lower than my lowest conversion so far, which would certainly be legal, but would be highly unpleasant.
This year, I converted just before the much larger dip that has happened over the last week. I know I can do another conversion of the same amount, then recharacterize the entire first conversion (plus however much of the second is needed to stay in the 15% bracket). However, more conversions and recharacterizations, presumably more hassle (and more odds of the IRS wanting to double-check someone's math, though that's a lesser concern). Of course, this whole strategy involves "calling a bottom" to some extent.
For people who use or have considered this strategy, what's your threshold? How do you decide that the market is "enough" lower than a previous conversion that a new conversion makes sense? I can envision the pathological case of doing another conversion every day the market is lower than my lowest conversion so far, which would certainly be legal, but would be highly unpleasant.
Last edited by archbish99 on Fri Oct 10, 2014 1:35 pm, edited 1 time in total.
I'm not a financial advisor, I just play one on the Internet.
Re: Threshold for Recharacterization
This thread is now in the Personal Finance (Not Investing) forum (when to recharacterize).
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Re: Threshold for Recharacterization
You are converting dollars, not shares of a mutual fund. Thus it doesn't matter when you convert,, Unless you try to time the 're-entry into a Roth.
Re: Threshold for Recharacterization
Are you aware of the waiting period rules? If I am reading this correctly, you can't put the money you recharacterized back into the Roth until January of next year. From IRA FAQ:archbish99 wrote:This will be the second year in an account I'm managing where I'll do a Roth conversion up to the top of the 15% bracket. The first year worked out quite well -- estimated the amount to convert, and then as part of tax prep recharacterized the amount that was into the 25% bracket.
This year, I converted just before the much larger dip that has happened over the last week. I know I can do another conversion of the same amount, then recharacterize the entire first conversion (plus however much of the second is needed to stay in the 15% bracket). However, more conversions and recharacterizations, presumably more hassle (and more odds of the IRS wanting to double-check someone's math, though that's a lesser concern). Of course, this whole strategy involves "calling a bottom" to some extent.
For people who use or have considered this strategy, what's your threshold? How do you decide that the market is "enough" lower than a previous conversion that a new conversion makes sense? I can envision the pathological case of doing another conversion every day the market is lower than my lowest conversion so far, which would certainly be legal, but would be highly unpleasant.
Do you have more than one Traditional IRA?Is there a minimum waiting period to reconvert the money to a Roth IRA following a recharacterization?
Yes, if you recharacterize all or part of a rollover or conversion to a Roth IRA, you cannot reconvert the amount recharacterized to the same or another Roth IRA until the later of:
•30 days after the recharacterization, or
•the year following the year of the rollover or conversion.
The waiting period to convert applies only to amounts you recharacterized. For example, you can convert amounts from a different traditional IRA to a Roth IRA immediately.
- archbish99
- Posts: 1649
- Joined: Fri Jun 10, 2011 6:02 pm
Re: Threshold for Recharacterization
Consider this case:LongerPrimer wrote:You are converting dollars, not shares of a mutual fund. Thus it doesn't matter when you convert,, Unless you try to time the 're-entry into a Roth.
I converted $9000 from a Traditional IRA to a Roth IRA. Both before and after the conversion, it was invested in fund XYZ, NAV of $10/share. The conversion results in a Roth IRA with 900 shares of XYZ.
Ten days later, XYZ has dropped to $9/share. I have the option of converting another $9000, placing another 1000 shares of XYZ in the Roth. At some point later (doesn't much matter when), I recharacterize the original conversion, moving 900 shares of XYZ back to the Traditional IRA. Net result: I've placed 100 extra shares in the Roth for the same tax cost.
It very much matters when you convert, because you pay taxes on the value at the time of conversion. Either you can convert the same shares for less cost, or you can convert more shares for the same cost.
You don't actually need more than one Traditional IRA, provided you do all the conversions prior to doing any recharacterizations. You can't reconvert the same money, but you can convert additional money that wasn't converted the first time, then recharacterize the initial conversion later.cherijoh wrote:Are you aware of the waiting period rules? If I am reading this correctly, you can't put the money you recharacterized back into the Roth until January of next year. From IRA FAQ:Do you have more than one Traditional IRA?Is there a minimum waiting period to reconvert the money to a Roth IRA following a recharacterization?
Yes, if you recharacterize all or part of a rollover or conversion to a Roth IRA, you cannot reconvert the amount recharacterized to the same or another Roth IRA until the later of:
•30 days after the recharacterization, or
•the year following the year of the rollover or conversion.
The waiting period to convert applies only to amounts you recharacterized. For example, you can convert amounts from a different traditional IRA to a Roth IRA immediately.
I'd just do all the recharacterizations at tax time 2015 anyway. See http://fairmark.com/retirement/roth-acc ... uce-taxes/, for example.
I'm not a financial advisor, I just play one on the Internet.
- House Blend
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Re: Threshold for [Resetting Roth Conversion]
^You probably know this, but for others reading along, you will need to have more than one Roth IRA if you are planning to do a "selective recharacterization" of multiple conversions.
If all of the conversions go into the same Roth IRA, then the gains in the entire account are prorated to recharacterized amounts. At least that's how Vanguard does it.
If all of the conversions go into the same Roth IRA, then the gains in the entire account are prorated to recharacterized amounts. At least that's how Vanguard does it.
- archbish99
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- Joined: Fri Jun 10, 2011 6:02 pm
Re: Threshold for [Resetting Roth Conversion]
True. It doesn't matter if it's all the same fund, as I understand it, but I keep a separate Roth account per fund I might want to recharacterize out of.
I'm not a financial advisor, I just play one on the Internet.
Re: Threshold for Recharacterization
The timing of the recharacterization very much matters - if the fund price is higher than it was at the time of conversion you will now owe a 10% penalty on the difference between the conversion amount and the recharacterization amount.archbish99 wrote::
Consider this case:
I converted $9000 from a Traditional IRA to a Roth IRA. Both before and after the conversion, it was invested in fund XYZ, NAV of $10/share. The conversion results in a Roth IRA with 900 shares of XYZ.
Ten days later, XYZ has dropped to $9/share. I have the option of converting another $9000, placing another 1000 shares of XYZ in the Roth. At some point later (doesn't much matter when), I recharacterize the original conversion, moving 900 shares of XYZ back to the Traditional IRA. Net result: I've placed 100 extra shares in the Roth for the same tax cost.
- archbish99
- Posts: 1649
- Joined: Fri Jun 10, 2011 6:02 pm
Re: Threshold for Recharacterization
Where do you find such a penalty? There's no IRA withdrawal occurring here, just money moving from a Traditional IRA to a Roth IRA and back to a Traditional IRA.cherijoh wrote:The timing of the recharacterization very much matters - if the fund price is higher than it was at the time of conversion you will now owe a 10% penalty on the difference between the conversion amount and the recharacterization amount.
I'm not a financial advisor, I just play one on the Internet.
Re: Threshold for [Resetting Roth Conversion]
There is no such penalty because a recharacterization must be done by transfer and is never a distribution. I think he might have been confusing this with a return of an excess contribution, which IS a distribution and then the earnings are taxable and subject to penalty.
Your strategy should be effective, and it is just subjective how many conversions and recharacterizations you want to deal with. You have to consider:
1) Avoiding the perception of a disallowed reconversion, and you obviously understand how to do that
2) How many explanatory statements you want to issue with your return. One for each recharacterization is required.
3) How many recharacterizations will irritate your IRA custodian. I have always thought that if too many people were using these strategies, some custodian would start charging for recharacterizations. Then others would follow. So far, no one wants to break the ice.
4) Whether too many will trigger IRS inquiry activity.
You will have to figure out what % of investment loss for the type of investment you are using will likely meet your thresholds for the above. Then if the markets get volatile as they are now, you would widen the threshold.
I think more people use strategies less focused on minimizing the conversion cost and use recharacterization strategies on the back end of the time window. One popular strategy is to do multiple conversions invested in ways that have minimal correlation with each other. They will look at which conversion gained the most or lost as the tax deadline approaches, and then recharacterize accordingly. With real big gains they may retain conversions that spill over to the next bracket because high gains reduces the effective cost of the conversion.
The markets have a way of making one strategy more effective in a certain year and a totally different one in other years. A lousy market can result in recharacterizing all your conversions unless you do at least one that is in a safe investment such as a CD. If you end up recharacterizing all of them, you lose the benefit of maxing out your bracket for that year. This hurts if you are aiming to squeeze all conversions into a narrow window before SS and/or RMDs begin.
I think your strategy in general will work as well as any. No major pitfalls with it other than perhaps having all of them under water once every few years as the tax deadline approaches.
Sometimes we have to remember that the tax deadline is only a deadline for action, it has no lasting indication that the value of a conversion will not grossly change in the next couple months.
Your strategy should be effective, and it is just subjective how many conversions and recharacterizations you want to deal with. You have to consider:
1) Avoiding the perception of a disallowed reconversion, and you obviously understand how to do that
2) How many explanatory statements you want to issue with your return. One for each recharacterization is required.
3) How many recharacterizations will irritate your IRA custodian. I have always thought that if too many people were using these strategies, some custodian would start charging for recharacterizations. Then others would follow. So far, no one wants to break the ice.
4) Whether too many will trigger IRS inquiry activity.
You will have to figure out what % of investment loss for the type of investment you are using will likely meet your thresholds for the above. Then if the markets get volatile as they are now, you would widen the threshold.
I think more people use strategies less focused on minimizing the conversion cost and use recharacterization strategies on the back end of the time window. One popular strategy is to do multiple conversions invested in ways that have minimal correlation with each other. They will look at which conversion gained the most or lost as the tax deadline approaches, and then recharacterize accordingly. With real big gains they may retain conversions that spill over to the next bracket because high gains reduces the effective cost of the conversion.
The markets have a way of making one strategy more effective in a certain year and a totally different one in other years. A lousy market can result in recharacterizing all your conversions unless you do at least one that is in a safe investment such as a CD. If you end up recharacterizing all of them, you lose the benefit of maxing out your bracket for that year. This hurts if you are aiming to squeeze all conversions into a narrow window before SS and/or RMDs begin.
I think your strategy in general will work as well as any. No major pitfalls with it other than perhaps having all of them under water once every few years as the tax deadline approaches.
Sometimes we have to remember that the tax deadline is only a deadline for action, it has no lasting indication that the value of a conversion will not grossly change in the next couple months.
- Peter Foley
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Re: Threshold for [Resetting Roth Conversion]
Alan S. wrote:
I use a modified approach to this method. I do a conversion from a total stock market mutual fund at the beginning of the year. If I get to the end of the year and have a loss, I will recharacterize and convert cash from a different account to a different Roth. I simply want to avoid taking a loss on a recharacterization while at the same time striving for simplicity. I'm in year 3 and have not had to recharcterize yet.
I agree with Alan - at least this is the most popular discussed. Each conversion has to go into a separate Roth as was mentioned by House Blend.I think more people use strategies less focused on minimizing the conversion cost and use recharacterization strategies on the back end of the time window. One popular strategy is to do multiple conversions invested in ways that have minimal correlation with each other. They will look at which conversion gained the most or lost as the tax deadline approaches, and then recharacterize accordingly. With real big gains they may retain conversions that spill over to the next bracket because high gains reduces the effective cost of the conversion.
I use a modified approach to this method. I do a conversion from a total stock market mutual fund at the beginning of the year. If I get to the end of the year and have a loss, I will recharacterize and convert cash from a different account to a different Roth. I simply want to avoid taking a loss on a recharacterization while at the same time striving for simplicity. I'm in year 3 and have not had to recharcterize yet.
Re: Threshold for Recharacterization
archbish99, Let's assume assume we are talking about a 2014 conversion. The problem with doing the recharacterizations in the next year (2015) is that you won't be able to re-convert those dollars in that year (2015). Hopefully you have other funds that you can convert next year (2015) and that the recharacterization goes back into a new Traditional IRA to enable you to do an additional conversion from the original Traditional IRA if the market continues to fall in the next year (2015).archbish99 wrote:You don't actually need more than one Traditional IRA, provided you do all the conversions prior to doing any recharacterizations. You can't reconvert the same money, but you can convert additional money that wasn't converted the first time, then recharacterize the initial conversion later.
I'd just do all the recharacterizations at tax time 2015 anyway. See http://fairmark.com/retirement/roth-acc ... uce-taxes/, for example.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
Re: Threshold for [Resetting Roth Conversion]
You are correct - that is probably what I was confusing it with.Alan S. wrote:There is no such penalty because a recharacterization must be done by transfer and is never a distribution. I think he might have been confusing this with a return of an excess contribution, which IS a distribution and then the earnings are taxable and subject to penalty.
- archbish99
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- Joined: Fri Jun 10, 2011 6:02 pm
Re: Threshold for Recharacterization
No, I don't believe that's the case. If you look at the time limits, it's the later of 30 days after the recharacterization, or the year following the conversion. So a 2014 conversion recharacterized in January 2015 can be converted again 30 days later. Unless I'm misreading something?celia wrote:archbish99, Let's assume assume we are talking about a 2014 conversion. The problem with doing the recharacterizations in the next year (2015) is that you won't be able to re-convert those dollars in that year (2015). Hopefully you have other funds that you can convert next year (2015) and that the recharacterization goes back into a new Traditional IRA to enable you to do an additional conversion from the original Traditional IRA if the market continues to fall in the next year (2015).
I'm not a financial advisor, I just play one on the Internet.
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Re: Threshold for Recharacterization
You are correct.archbish99 wrote:If you look at the time limits, it's the later of 30 days after the recharacterization, or the year following the conversion. So a 2014 conversion recharacterized in January 2015 can be converted again 30 days later. Unless I'm misreading something?
Re: Threshold for [Resetting Roth Conversion]
A word of caution. When you recharacterize, you cannot pick a particular asset. It applies to the Roth IRA as a whole. Refer to Pub 590, worksheet 1-3. Also you can look at Section "1.408A–5 Recharacterized contributions", which says:
http://www.gpo.gov/fdsys/pkg/CFR-2014-t ... 408A-5.pdf
The document is at URL:(5) In the case of multiple contributions
made to an IRA for a particular
year that are eligible for recharacterization,
the IRA owner can choose (by
date and by dollar amount, not by specific
assets acquired with those dollars)
which contribution, or portion thereof,
is to be recharacterized.
http://www.gpo.gov/fdsys/pkg/CFR-2014-t ... 408A-5.pdf
Re: Threshold for [Resetting Roth Conversion]
Note that point (5) above applies with respect to the requirement that a recharacterization must be applied to all or part of a contribution (conversion in this case) done on a specific date. The earnings calculation is done using the adjusted results of the entire Roth IRA to determine the dollar values that transfer back to the TIRA.ayrehead wrote:A word of caution. When you recharacterize, you cannot pick a particular asset. It applies to the Roth IRA as a whole. Refer to Pub 590, worksheet 1-3. Also you can look at Section "1.408A–5 Recharacterized contributions", which says:The document is at URL:(5) In the case of multiple contributions
made to an IRA for a particular
year that are eligible for recharacterization,
the IRA owner can choose (by
date and by dollar amount, not by specific
assets acquired with those dollars)
which contribution, or portion thereof,
is to be recharacterized.
http://www.gpo.gov/fdsys/pkg/CFR-2014-t ... 408A-5.pdf
But once that amount is calculated, the taxpayer is allowed to choose which assets are actually transferred back to the TIRA to complete that dollar value. If taxpayer does not want to buy or sell assets and chooses to send back to the TIRA assets he thinks have the least potential for gains, he can do that. However, since most assets rise or fall constantly, most brokers use a format under which you can provide an instruction similar to the following:
" Recharacterize 30k of my 50k conversion done xx/xx/2014. Transfer all my shares of XYZ and complete the recharacterization with shares of ABC as required." Or taxpayer could indicate that 60 shares of JKL are to be transferred and any remaining balance to be filled with MM fund shares.
This format allows the recharacterization to be done at one time regardless of daily market swings and will get the particular issues desired transferred to the TIRA, leaving other assets with near term growth potential in the Roth.