Re-characterization Analysis -- Should I or Shouldn't I

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
User avatar
WoodSpinner
Posts: 516
Joined: Mon Feb 27, 2017 1:15 pm

Re-characterization Analysis -- Should I or Shouldn't I

Post by WoodSpinner » Tue Feb 20, 2018 9:14 pm

All,

I could use some help in analyzing a tax question--should I re characterize my Roth Conversion or leave it be?

Background
1. I did an In-Kind Roth Conversion in 2017 of $34,315.45 (my very first one) into a new Roth Account. The only asset converted was VTI shares.
2. It looks like the Marginal Rate for this conversion is 38.22% (Fed + State). It cost me $13,116 to convert $34,315 which gave me a 38.22% Marginal Rate.
3. My expected Marginal Rate for 2018 (with the New Tax Cuts) is 31.3% (6.92% increase)
4. It seems like I am paying about $2375.26 in Extra Tax (2017 Rates compared to 2018 Rates).
5. The assets have appreciated $3786.56 (11.49% increase since Conversion).

Puzzled how to evaluate the wisdom of keeping the conversion or re characterizing it.

I am leaning towards keeping the conversion since the appreciation is larger than the excess tax paid.

What is the best way to analyze the issue?

Thanks in Advance

WoodSpinner :?

Church Lady
Posts: 431
Joined: Sat Jun 28, 2014 7:49 pm

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Church Lady » Tue Feb 20, 2018 9:57 pm

I am not sure what is optimal, but what motivated you to convert in 2017? Do you have a deadline to meet? For example, I'd like to convert a certain percent of my tax deferred accounts by a certain age. Therefore, I have a 'deadline'.

Given my deadline/goal, I would probably not worry about it and move on to next year's Roth conversion. I would think of it more as having the chance to save on the 2018 conversion than having overpaid for the 2017 conversion.

But you may not have any particular deadline, or may not aspire to more conversions.

There's also a danger that you'll recharacterize, only to see VTI increase even more. Thus, your tax rate on conversion is lower, but you pay tax on more of it. Any danger of the added value pushing you into the next bracket? Or I should say, how much would VTI have to increase to push you into a new bracket, or to cause you to pay another 2375.26 to convert in 2018? Maybe that's how you should think of it.

No expert here. Just some thoughts.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

Spedward
Posts: 140
Joined: Mon Jun 13, 2011 4:48 pm

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Spedward » Tue Feb 20, 2018 10:03 pm

I thought the ability to recharacterize is now a thing of the past without grandfather, no?

Church Lady
Posts: 431
Joined: Sat Jun 28, 2014 7:49 pm

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Church Lady » Tue Feb 20, 2018 10:14 pm

We can recharacterize 2017 conversions. Starting with 2018 conversions, we won't be able to recharacterize.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

User avatar
Svensk Anga
Posts: 425
Joined: Sun Dec 23, 2012 5:16 pm

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Svensk Anga » Tue Feb 20, 2018 10:34 pm

What I do is divide the taxes from the conversion by the appreciated value at decision time and compare that rate to my expected marginal rate once RMD's start. If the conversion tax rate via this method is lower than (or just tolerably close to) the future marginal rate, I keep the conversion.

I recommend requesting an extension and then revisiting the question in time for the October 15 deadline. It might be clearer one way or the other by then.

Alan S.
Posts: 7650
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Alan S. » Tue Feb 20, 2018 10:52 pm

Svensk Anga wrote:
Tue Feb 20, 2018 10:34 pm
What I do is divide the taxes from the conversion by the appreciated value at decision time and compare that rate to my expected marginal rate once RMD's start. If the conversion tax rate via this method is lower than (or just tolerably close to) the future marginal rate, I keep the conversion.

I recommend requesting an extension and then revisiting the question in time for the October 15 deadline. It might be clearer one way or the other by then.
Good points. You can also file your return in April and pay the taxes, then recharacterize before 10/15 if you change your mind. Then amend your return. A partial recharacterization is also an option, eg hedge your bets by recharacterizing half, keeping half.

There may be a psychological reason to keep this conversion. Not only does it have a decent gain (at this point), but the inability to convert from here on will tend to make most people more conservative with future conversion amounts since they will be stuck with the tax bill regardless of how much the conversion drops in value.

Note that this is also the last year for the reconversion time limit. If a 2017 conversion is recharacterized in 2018, that amount cannot be reconverted to Roth until 30 days has passed since the date of recharacterization. Of course, if you convert more before the recharacterization is done, it can't be a disallowed reconversion.

Spedward
Posts: 140
Joined: Mon Jun 13, 2011 4:48 pm

Re: Re-characterization Analysis -- Should I or Shouldn't I

Post by Spedward » Tue Feb 20, 2018 11:21 pm

Church Lady wrote:
Tue Feb 20, 2018 10:14 pm
We can recharacterize 2017 conversions. Starting with 2018 conversions, we won't be able to recharacterize.
Yep - you are correct! Got my years messed up, or perhaps provisions, I guess. Thanks.

Post Reply