Under previous law, retirement savers could recharacterize, meaning reverse or undo, a conversion to a Roth IRA from a traditional IRA (or from a 401(k) or 403(b) plan). This allowed investors to unwind the conversion and the associated tax consequences. Retirement savers had until December 31 of each year to effect a conversion for that year. They then generally would have until October 15 of the year following the conversion (which is the extended due date for the tax return for the year of the conversion) to undo the transaction.
For example, Ms. Bruno said, an investor might want to undo a $50,000 conversion to a Roth IRA if the market subsequently fell dramatically and the account value dropped to $40,000. In this instance, the investor would still pay taxes based on the $50,000 account value at the time of the conversion.
Before the change, investors could undo the transaction and avoid this higher tax liability. But the new law includes a repeal of the rule that allows for those transactions. Ms. Bruno points out that investors who made a conversion in 2017 should be aware that they still have time to recharacterize that conversion. “While the new tax law prohibits recharacterization of a conversion made after December 31, 2017, investors who made a conversion in 2017 still have until October 15, 2018, to recharacterize it,” Ms. Bruno said.
The change for post-2017 conversions could potentially complicate things for some investors.
“Under these circumstances, you suddenly have all this additional income and maybe the Roth conversion is pushing you into a higher tax bracket, and you will now no longer be able to undo it,” Ms. Bruno said.
Importantly, the new law does not change the existing rules for recharacterizations of contributions to a Roth or traditional IRA; these continue to be permitted. For example, an individual may continue to make a contribution for a year to a Roth IRA and, before the extended due date for the individual’s income tax return for that year, recharacterize it as a contribution to a traditional IRA. An individual may also make a contribution to a traditional IRA and convert that traditional IRA to a Roth IRA for a year but could not then unwind the conversion through a recharacterization.
Investors who are considering a recharacterization of a contribution or 2017 conversion should consult a qualified tax advisor for advice.
We recommend that you consult a tax or financial advisor about your individual situation.
All investing is subject to risk, including the possible loss of principal.
The information contained herein does not constitute tax advice, and cannot be used by any person to avoid tax penalties that may be imposed under the Internal Revenue Code.