Roth IRA Recharacterization

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beebee5004
Posts: 11
Joined: Fri Feb 22, 2019 6:24 pm

Roth IRA Recharacterization

Post by beebee5004 »

I made a 2018 contribution to my Roth IRA last year, and in working on my taxes recently, I realized that I was not eligible to make a 2018 contribution. I have read some about doing a recharacterization of my contribution from Roth to Traditional to avoid paying the early withdrawal penalty. I am not eligible to deduct my Traditional IRA contribution, but my understanding is that if I recharacterize, I would at least avoid the early withdrawal penalty of the contribution.

I called my IRA custodian to ask if I could recharacterize, and the representative with whom I was speaking reluctantly said, "Most of the time, you just want to move it into a taxable account." He seemed to be saying that he wasn't going to help me with the recharacterization or that he would not allow it. Is there are reason that recharacterizing in my situation is not a good idea, is not allowed, or would not be beneficial for me, or did I just misunderstand him?
Silk McCue
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Joined: Thu Feb 25, 2016 7:11 pm

Re: Roth IRA Recharacterization

Post by Silk McCue »

Welcome to Bogleheads!

Read this article on performing a Backdoor Roth. If you have no existing IRAs with a balance on 12/31/2019 you can have the Roth recharacterized to Traditional (treating it as non deductible) then immediately convert that to a Roth. You can do that every year.

Backdoor Roth

If you qualify to do this, once you are done then fire your incompetent and lazy custodian.

Cheers
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FiveK
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Re: Roth IRA Recharacterization

Post by FiveK »

beebee5004 wrote: Fri Feb 22, 2019 6:32 pm Is there are reason that recharacterizing in my situation...would not be beneficial for me...?
Yes, if you currently have a large balance of pre-tax IRA money that you cannot roll into some 401k or 403b plan. Otherwise, no.

The backdoor Roth wiki article should explain, but just ask if after reading it isn't clear why.
Topic Author
beebee5004
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Joined: Fri Feb 22, 2019 6:24 pm

Re: Roth IRA Recharacterization

Post by beebee5004 »

Thank you for the responses. I will try to make time to read that article.

The thing that was confusing to me about my interaction with the custodian is that the custodian is Schwab, and I have in general had very positive experiences with their customer service. I was very surprised when this representative seemed reluctant to help me. This was the first time I'd had interaction with Schwab's retirement group. Maybe the quality of their customer service in this area is not as high as in other areas.
Alan S.
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Re: Roth IRA Recharacterization

Post by Alan S. »

beebee5004 wrote: Fri Feb 22, 2019 6:32 pm I made a 2018 contribution to my Roth IRA last year, and in working on my taxes recently, I realized that I was not eligible to make a 2018 contribution. I have read some about doing a recharacterization of my contribution from Roth to Traditional to avoid paying the early withdrawal penalty. I am not eligible to deduct my Traditional IRA contribution, but my understanding is that if I recharacterize, I would at least avoid the early withdrawal penalty of the contribution.

I called my IRA custodian to ask if I could recharacterize, and the representative with whom I was speaking reluctantly said, "Most of the time, you just want to move it into a taxable account." He seemed to be saying that he wasn't going to help me with the recharacterization or that he would not allow it. Is there are reason that recharacterizing in my situation is not a good idea, is not allowed, or would not be beneficial for me, or did I just misunderstand him?
The custodian cannot deny you a recharacterization under the IRS tax code, however if you asked the custodian in any way for advice it opens up a can of worms. As others have indicated recharacterization can have it's advantages and disadvantages depending on several variables that apply to any of the recharacterization options that include:

1) Excess removal with earnings, which results in the earnings being taxable and subject to penalty in the year IN WHICH you made the contribution.
2) In cases of high gains on your excess contribution, the taxes and penalty for removal might exceed the cost of the 6% excise tax for 2018. So you might intentionally pay the excise to allow those gains to remain in the Roth IRA, and just remove the excess amount only in 2019.
3) Same as 2 above except if you expect to be eligible for a Roth contribution in 2019, Form 5329 will assign the 2018 contribution to 2019 and you do not have to take any distribution. Of course, you lose IRA contribution space for 1 year doing this.
4) When considering the effects of recharacterization, determine if you can deduct a TIRA contribution (usually you cannot), and if not then you must report the recharacterized 2018 contribution as non deductible on Form 8606. You are then stuck with the 8606 indefinitely unless you can roll the pre tax IRA balance into your workplace plan, OR if you convert your entire non Roth IRA balance to a Roth.
5) All of the above have reporting implications, which differ slightly in the amount of work and/or additional transactions needed to best resolve the entire excess situation.

NOTE: Whether you have a gain or loss on your excess contribution factors heavily into your decision. Removal of contributions when there is a loss will not result in any tax or penalty.

So, you can see that the best decision depends on several variables including tax cost and extra filing work. No custodian will attempt to explain all these considerations to help you make the best choice, but once you decide they must honor your decision.
cherijoh
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Re: Roth IRA Recharacterization

Post by cherijoh »

beebee5004 wrote: Fri Feb 22, 2019 6:32 pm I made a 2018 contribution to my Roth IRA last year, and in working on my taxes recently, I realized that I was not eligible to make a 2018 contribution. I have read some about doing a recharacterization of my contribution from Roth to Traditional to avoid paying the early withdrawal penalty. I am not eligible to deduct my Traditional IRA contribution, but my understanding is that if I recharacterize, I would at least avoid the early withdrawal penalty of the contribution.

I called my IRA custodian to ask if I could recharacterize, and the representative with whom I was speaking reluctantly said, "Most of the time, you just want to move it into a taxable account." He seemed to be saying that he wasn't going to help me with the recharacterization or that he would not allow it. Is there are reason that recharacterizing in my situation is not a good idea, is not allowed, or would not be beneficial for me, or did I just misunderstand him?
How much earnings are we talking about on your 2018 Roth contribution as of today? Your early withdrawal penalty may be tiny depending on when the contribution was made last year.

Would you be eligible to do a "clean" Backdoor Roth (i.e., only pay tax on whatever earnings for your 2018 contribution) or do you have any other funds in a Traditional IRA that would activate the pro-rata rules? If the latter can you roll them into your 401k?

If you aren't planning to do a Roth Conversion and your account didn't have large gains, then I would agree with the Schwab rep and just take the money out and pay the penalty. Keeping track of a small non-deductible contribution over time may be more trouble than it is worth.
Topic Author
beebee5004
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Joined: Fri Feb 22, 2019 6:24 pm

Re: Roth IRA Recharacterization

Post by beebee5004 »

Thank you for all of the very helpful information.
No custodian will attempt to explain all these considerations...
Ok, that makes sense that he would not be willing to explain all of that.
Removal of contributions when there is a loss will not result in any tax or penalty.
Oh, so all I would need to do would be to find some security that has a loss, sell that, and remove the funds from that sale to avoid the early withdrawal penalty?
Topic Author
beebee5004
Posts: 11
Joined: Fri Feb 22, 2019 6:24 pm

Re: Roth IRA Recharacterization

Post by beebee5004 »

How much earnings are we talking about on your 2018 Roth contribution as of today?
That question is a little confusing to me, because when I talked to the Schwab representative, I thought he told me that I could sell whatever securities I wanted to make cash for the removal of the excess contribution. When you refer to the "earnings ... on [my] 2018 Roth contributions," that gives me the impression that the earnings have to be calculated based on how I used the money that I contributed last year. I asked the representative that, and my understanding was that he was saying that I did not necessarily have to sell the shares I bought last year in order to get cash to take out the excess contribution. But I would not be surprised if I missed something.
Would you be eligible to do a "clean" Backdoor Roth (i.e., only pay tax on whatever earnings for your 2018 contribution) or do you have any other funds in a Traditional IRA that would activate the pro-rata rules? If the latter can you roll them into your 401k?
I will have to educate myself before I can answer those questions.
If you aren't planning to do a Roth Conversion and your account didn't have large gains, then I would agree with the Schwab rep and just take the money out and pay the penalty. Keeping track of a small non-deductible contribution over time may be more trouble than it is worth.
Ok. Thank you for the helpful response!
Topic Author
beebee5004
Posts: 11
Joined: Fri Feb 22, 2019 6:24 pm

Re: Roth IRA Recharacterization

Post by beebee5004 »

Ok, I found the page linked below that explains how to calculate the earnings on contributions. Now I see that the earnings rate is calculated by the change in value of the entire account, not individual securities.

https://www.investopedia.com/articles/r ... 042804.asp

I realize that the IRA custodian will calculate the earnings, but I wanted to have some understanding of what was going on when I got the tax bill.

Thank you again for the help, everyone.
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