A recharacterization allows IRA owners to “fix” or “move” a contribution to another type of IRA. This strategy not only allows IRA owners increased flexibility, but also can often reduce or eliminate an unwanted tax bill or future IRS penalties.
Types of Recharacterization
- Changing a traditional IRA contribution to a Roth IRA contribution
- Changing a Roth IRA contribution to a traditional IRA contribution
Why Would a Taxpayer Want to Recharacterize?
- If the client’s traditional IRA contribution is non-deductible and eligible to be a Roth IRA contribution
- If the client’s Modified Adjusted Gross Income (MAGI) is too high to make a Roth IRA contribution
Recharacterization of a Traditional IRA Contribution to a Roth IRA
The IRS allows taxpayers that contribute to a traditional IRA the opportunity to recharacterize (move) that contribution (plus earnings or minus any loss) to a Roth IRA. Note that in order to move a traditional IRA contribution to a Roth IRA, the taxpayer’s MAGI must be under the allowable limits for the year the contribution is intended ($140,000 for a single filer and 208,000 for married couples filing a joint return for 2021).
Recharacterization of a Roth IRA Contribution to a Traditional IRA
The IRS allows taxpayers that contribute to a Roth IRA the opportunity to recharacterize (move) that contribution (plus earnings or minus any loss) to a traditional IRA. There are no MAGI limits for non-deductible contributions to traditional IRAs, and therefore, taxpayers may generally elect to recharacterize Roth contributions to a traditional IRA.
To qualify for a recharacterization of a contribution between IRAs, the transfer must be completed by October 15 of the year following the year the contribution was intended for. The individual must have also filed his or her Federal income tax return by the normal filing deadline or timely requested a tax filing extension.
- Inform the custodian to complete a transfer of the original contribution amount from one IRA to another. At Stifel, the client must complete and sign the IRA Recharacterization Request Form. The transfer must include any gain (or loss) from the original date of the contribution, which the custodian will calculate.
- Report the recharacterization with the tax return on IRS Form 8606 using the date of the original contribution. The individual may have to amend the return if the recharacterization is for a previous year’s contribution.
- Custodian will issue 1099-R and 5498 tax forms confirming the recharacterization to the taxpayer and IRS.
The ability to recharacterize ineligible IRA contributions provides flexibility to IRA holders. Remember, a recharacterization must occur by tax filing deadline plus extension (October 15, 2021, for 2020 contributions).
Please note that this information is for educational purposes only. Stifel does not provide tax advice. You should consult with your tax advisor regarding your situation.