How does IRA rechar work?

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Topic Author
aiyuanuc
Posts: 78
Joined: Fri May 03, 2019 8:16 am

How does IRA rechar work?

Post by aiyuanuc »

I will need to recharacterize ~$6500 (between my wife and me) Roth IRA contributions we made for 2019 to traditional IRA. Have done some research and it seems that as long as I do so before Apr 1 2020 we should be fine. Still, a couple of questions since it's our first time doing this:

1. Some online posts say that Fidelity will not issue 1099-R for the recharacterization if it's done in 2020. How do I report the rechar then?

2. Some posts also mention Form 8606, but from the form instructions, it seems that I won't need to file it?

3. What are the possible pitfalls if we don't do the rechar before 2019 year-end?

4. Combining questions 1 and 2, for our specific situation, what do I have to do when filing 2019 returns?

Thanks!
Topic Author
aiyuanuc
Posts: 78
Joined: Fri May 03, 2019 8:16 am

Re: How does IRA rechar work?

Post by aiyuanuc »

Could anybody please help? I have done due diligence.. just want to get some confirmation..
mhalley
Posts: 8871
Joined: Tue Nov 20, 2007 6:02 am

Re: How does IRA rechar work?

Post by mhalley »

Call fidelity and ask them, but why not just go ahead with the conversion before 2020? If you know its a problem, fix it today.
who needs to file a form 8606:
Basically, you must file Form 8606 for every year you contribute after-tax amounts (non-deductible IRA contribution) to your Traditional IRA, and every year you receive a distribution from your IRA as long as you have after-tax amounts, including rollovers of after-tax amounts from qualified plans, in any of your traditional, SEP or SIMPLE IRAs.
https://www.investopedia.com/articles/r ... 030304.asp
If you are over the limits and make a roth contribution, then you will owe taxes of 6% each year on the over contribution.
The Penalties for Excess Contributions
The penalty for an ineligible contribution is 6% of the excess amount. You pay this penalty when you file your income tax return using IRS Form 5329.

If you don’t fix the mistake, you’ll owe the penalty each year the excess remains in your account. If you’re not eligible to take a qualified distribution from your IRA to fix the mistake, you’ll pay an additional 10% early withdrawal penalty on earnings (interest).
https://www.investopedia.com/articles/r ... 042804.asp
Form 8606 will need to be filed:
https://www.thebalance.com/forgot-to-fi ... as-3973986
Are you planning on/eligible to do backdoor roths in the future?
https://www.bogleheads.org/wiki/Backdoor_Roth
cas
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Re: How does IRA rechar work?

Post by cas »

aiyuanuc wrote: Mon Dec 23, 2019 2:50 pm
I will need to recharacterize ~$6500 (between my wife and me) Roth IRA contributions [ . . .]

2. Some posts also mention Form 8606, but from the form instructions, it seems that I won't need to file it?
I have picked up only enough (mostly from reading retiredjg, Alan S, Duckie and others) to be dangerous. But it is holiday time, retiredjg doesn't seem to be around, and Alan S is busy with SECURE.

So...

I'm a bit concerned about what you write because...

The 8606 becomes involved because it is needed to document the non-deductible basis you create in a traditional IRA by doing the recharacterization. If you do not document the non-deductible basis on the Form 8606, you will end up, sooner or later, unnecessarily paying tax on the $6500 twice.

But, generally, creating non-deductible basis is optimal only if you can immediately do a conversion back to Roth (a "Backdoor Roth"). In other words, people deal with an excess contribution to a Roth IRA by "recharacterizing" it to a non-deductible traditional IRA contribution only if they then immediately convert that non-deductible traditional IRA contribution to Roth. And they do this only if they are a good candidate to do a Backdoor Roth

You haven't really said where you stand with respect to being a good candidate for a Backdoor Roth. (See Boglehead's wiki on Backdoor Roth, especially the pro-rata rule.) If you are fine with a Backdoor Roth, everything below may be irrelevant.

If someone is not a good candidate to to a Backdoor Roth then doing a recharacterization may be something you end up regretting. It depends on the person, but there are definitely people who have reported on the forum that they didn't really understand the implications of introducing non-deductible basis into their IRA mix and that, in retrospect, they wish they hadn't done it.

In the above case, I think there is something else ... called a return of excess contribution (I think?) that they might have preferred to do. The excess contribution to Roth gets undone (has to be done by the Roth custodian) and the funds returned to the person's taxable account (rather than their traditional IRA). (There is no tax on the returned contribution, but there might or might not be taxable earnings on the contribution also returned.) Investing the returned funds in taxable (as opposed to recharacterizing them to a non-deductible IRA contribution) has the advantage of avoiding the whole pro-rata ongoing Form 8606 issue that can last your whole life and even into your beneficiaries' lives. You also get better tax treatment (lower qualified dividend/long term capital gain tax rates) on the ongoing (compounding) earnings on the $6500 than you would on the earnings (when withdrawn at ordinary tax rates) on a non-deductible IRA contribution.


But maybe I don't know what I'm writing about. I wouldn't put too much weight on it. But I seem to have turned up a bunch of discussion on "return of contribution" by entering "return of contribution Roth excess" into the Boglehead's search box.

Or maybe you are a good candidate for a Backdoor Roth, so the above commentary isn't relevant to you anyway.

Given the holiday time, I don't know how much chance you have of the true experts showing up any time soon, though.
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Duckie
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Re: How does IRA rechar work?

Post by Duckie »

aiyuanuc wrote:Some online posts say that Fidelity will not issue 1099-R for the recharacterization if it's done in 2020. How do I report the rechar then?
Whether you get a 1099-R or not you report the recharacterization by:
  1. If filing taxes the old way on paper you add a statement on an extra sheet of paper. Write that you contributed $XX to a Roth IRA for 2019 on date AA and because your income went above the limit you recharacterized $YY to a Traditional IRA on date BB. Since both of you went over the limit there will be two statements.
  2. If filing taxes using software like TurboTax make sure it knows you contributed $XX to the Roth IRA and recharacterized $YY to a TIRA. A blank statement will pop up and you type the above information. Again, two separate statements.
  3. If filing taxes using a tax-preparer make sure s/he has the above information.
The draft instructions for Form 8606 page 4 shows an example.
Some posts also mention Form 8606, but from the form instructions, it seems that I won't need to file it?
You don't need it for the actual recharacterization (unless you only recharacterized part of the contribution) but if you are above the limit for Roth contributions you are also above the limit for TIRA deductions so the TIRA will be at least partly non-deductible. You file Form 8606 to report the non-deductible basis. Again, there will be two Form 8606s.
Combining questions 1 and 2, for our specific situation, what do I have to do when filing 2019 returns?
Per the draft instructions for Form 8606 page 4:
  • "You made a contribution to a Roth IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a traditional IRA. Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2019, include the amount transferred from the Roth IRA on Form 1040 or 1040-SR, line 4a; or Form 1040-NR, line 16a. If the recharacterization occurred in 2020, report the amount transferred only in the attached statement, and not on your 2019 or 2020 tax return."
The instructions also cover Return of IRA Contributions if you want to go that way.
Topic Author
aiyuanuc
Posts: 78
Joined: Fri May 03, 2019 8:16 am

Re: How does IRA rechar work?

Post by aiyuanuc »

Thanks Duckie! Our situation is actually much simpler: we contributed to Roth early in the year and later found that we will be paying 22% Fed + 6.5% State on it so would like to recharacterize it to traditional IRA to get us back into the 12% Fed bracket. So recharacterized portion is fully deductible so there is not non-deductible basis to worry about. And yes, it's a partial recharacterization for both of us.

My understanding is that I don't need to file Form 8606? And according to the irs instructions that you posted:

"You made a contribution to a Roth IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a traditional IRA. Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2019, include the amount transferred from the Roth IRA on Form 1040 or 1040-SR, line 4a; or Form 1040-NR, line 16a. If the recharacterization occurred in 2020, report the amount transferred only in the attached statement, and not on your 2019 or 2020 tax return."

It seems that I don't need to file 8606 and if I recharacterize in 2020, all I need to do is to report the recharacterized portion in Schedule 1 and attach a statement? No other paperwork?

Duckie wrote: Mon Dec 23, 2019 7:25 pm
aiyuanuc wrote:Some online posts say that Fidelity will not issue 1099-R for the recharacterization if it's done in 2020. How do I report the rechar then?
Whether you get a 1099-R or not you report the recharacterization by:
  1. If filing taxes the old way on paper you add a statement on an extra sheet of paper. Write that you contributed $XX to a Roth IRA for 2019 on date AA and because your income went above the limit you recharacterized $YY to a Traditional IRA on date BB. Since both of you went over the limit there will be two statements.
  2. If filing taxes using software like TurboTax make sure it knows you contributed $XX to the Roth IRA and recharacterized $YY to a TIRA. A blank statement will pop up and you type the above information. Again, two separate statements.
  3. If filing taxes using a tax-preparer make sure s/he has the above information.
The draft instructions for Form 8606 page 4 shows an example.
Some posts also mention Form 8606, but from the form instructions, it seems that I won't need to file it?
You don't need it for the actual recharacterization (unless you only recharacterized part of the contribution) but if you are above the limit for Roth contributions you are also above the limit for TIRA deductions so the TIRA will be at least partly non-deductible. You file Form 8606 to report the non-deductible basis. Again, there will be two Form 8606s.
Combining questions 1 and 2, for our specific situation, what do I have to do when filing 2019 returns?
Per the draft instructions for Form 8606 page 4:
  • "You made a contribution to a Roth IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a traditional IRA. Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2019, include the amount transferred from the Roth IRA on Form 1040 or 1040-SR, line 4a; or Form 1040-NR, line 16a. If the recharacterization occurred in 2020, report the amount transferred only in the attached statement, and not on your 2019 or 2020 tax return."
The instructions also cover Return of IRA Contributions if you want to go that way.
Spirit Rider
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Re: How does IRA rechar work?

Post by Spirit Rider »

aiyuanuc wrote: Mon Dec 23, 2019 2:50 pm Have done some research and it seems that as long as I do so before Apr 1 2020 we should be fine.
A small clarification.

You have until your 2019 tax filing deadline (4/15/2020) including extensions (10/15/2020) to do a 2019 recharacterizarion.
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Duckie
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Re: How does IRA rechar work?

Post by Duckie »

aiyuanuc wrote:My understanding is that I don't need to file Form 8606?
If you're under the income limits and are recharacterizing to take the deduction, then no you don't need to file Form 8606.
It seems that I don't need to file 8606 and if I recharacterize in 2020, all I need to do is to report the recharacterized portion in Schedule 1 and attach a statement? No other paperwork?
That's how it looks to me.
MarkNYC
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Joined: Mon May 05, 2008 7:58 pm

Re: How does IRA rechar work?

Post by MarkNYC »

Even though it's not a taxable event, the recharacterization of a traditional or Roth IRA contribution must be reported on Form 1099-R.
kambyvk
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Re: How does IRA rechar work?

Post by kambyvk »

I had to do this recently. You will have to do a 'return of excess' and the Fidelity rep can take you through the process while on call and it takes a few button clicks to complete. Basically this will result in your Roth IRA contribution returned to your cash account and the gains on your Roth still kept in the Roth IRA account (I was told by Fidelity that IRS rules are not clear on what to do with the gains so they suggested leaving them there).

For a 2018 Roth contribution which also had to be reversed, I did a recharacterization to a nondeductible IRA - again done with the Fidelity rep assisting me online. Equally simple process.
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