Roth IRA Re-characterization

That’s one heck of a tongue twister, isn’t it? As difficult as it may be to say three times fast, it’s actually much easier to think of a Roth IRA re-characterization as a “do over.” A re-characterization lets you undo a conversion you made earlier in the year.

Why Re-characterize?

There are a variety of reasons why you might what to re-characterize a Roth IRA conversion. While this doesn’t apply in 2010, in past years you might have done it for income reasons (in years past, there were income restrictions on who could convert a Traditional IRA to a Roth IRA). More commonly, you may realize that you can’t or don’t want to pay the taxes on the conversion for a variety of reasons (job loss, divorce, changing priorities). It could be that you misunderstood what you were doing or that after the conversion your account lost money (so you would pay less in tax if you converted today).

Whatever the reason, a re-characterization lets you undo the conversion as if it never happened.

Re-characterization Rules

The best way to understand this is that you can usually undo a conversion from a Traditional IRA to a Roth IRA. There are a few exceptions, such as if you contributed directly (regular contribution) to a Roth IRA and meant to contribute to a Traditional IRA, you can make that change as well. You can’t re-characterize rollovers or employer contributions that were made into a Traditional IRA into a contribution to a Roth IRA.

Re-characterizing

In general, the due date to undo your conversion or contribution is the due date of your tax return for that year, including extensions. So if you made the change for 2010, you have until April 15th, 2011 to re-characterize.

To re-characterize, talk with your broker, the one that manages your IRA, to find out what the procedure is to re-characterize your Roth IRA. They will have specific procedures and more advice on what other considerations you may need to think about during the re-characterization.

Jim writes about personal finance at Bargaineering.com.