What’s a Roth recharacterization?
Rebecca Katz: Please explain Roth recharacterization? Is this the “Oopsie, I converted and I
shouldn’t have done that”?
Maria Bruno: Yes, but it’s not always an oopsie. It could be a very viable strategy that
someone is employing. Actually, we’re having these conversations right now because at
the end of last year there’s a lot of uncertainty around what would happen with 2013 tax
rates. So some investors, actually, decided they would convert and then maybe decide
to recharacterize later. So what a recharacterization is, it’s really almost a mulligan; the
IRS lets us do a do-over. So, if you contribute, if you convert to a Roth IRA, or even if you
contribute to a Roth IRA and then decide that you want to reverse that, the IRS allows you
to do that.
Meet the speakers
Rebecca Katz
Moderator
Now, there are some stipulations, there’s time, there’s holding-period requirements. So,
if you converted last year, for instance, and you want to recharacterize this year, you have
until, essentially, October 15 to do that. So it’s a tax-filing deadline or a tax extension.
So you can convert them. Basically, what it does is, it takes whatever, whether it’s a partial
recharacterization or a full recharacterization, brings that back into a traditional IRA. So any
earnings or losses would be carried back over into that traditional IRA. The end result is as
if the conversion never happened or the Roth contribution never happened.
Joel Dickson: Where this can be valuable is, for example, although this is not as likely this
year given that we’ve had pretty robust financial market returns, but let’s take that 100,000
dollars that we had been talking about earlier and you converted that from a traditional
to a Roth IRA. Let’s assume that it was fully taxable, so it was all 100,000 dollars of
pre-tax dollars.
If the investment that you put it into in the Roth IRA were to have gone from 100,000 to
80,000, declined 20 percent; sort of go, “Well, why should I pay taxes on 100,000 dollars
when right now the account is worth 80,000 dollars?” So recharacterizing back to the
traditional IRA, where now you have 80,000 dollars, and then once you get over the certain
requirements to then do a reconversion, which, basically, is either 30 days following the
recharacterization or the next tax year—it sort of depends on where you are in the tax
cycle—you would now just reconvert 80,000 dollars and pay tax on 80,000 instead of
paying tax on 100,000 if you wouldn’t have recharacterized.
Rebecca Katz: Assuming the markets didn’t go back up.
Maria Bruno: So there’s holding periods, so you’re kind of at the mercy of the markets
it’s almost depending on how you’re invested. You can actually put the monies back
into the traditional IRA and keep it there, or you can actually reconvert after the
holding period expires.
(continued on next page)
Maria Bruno
Vanguard Investment
Strategy Group
Joel Dickson
Vanguard Investment
Strategy Group
Joel Dickson: One of the things that I do think we have to be careful about in 2013, because
Maria mentioned there was a lot of uncertainty about tax rates—we have the fiscal cliff, all
that kind of stuff—for some people, tax rates increased in 2013 from where they were in
2012, either through all of the deductions changing, or through the Medicare, or through
ordinary income tax rates. So even if the account went down in terms of the value of the
conversion from a traditional to a Roth, it might not make sense to recharacterize because
now you would be reconverting in 2013 or 2014 at potentially higher tax rates. And so what
matters is the total tax bill, not so much the amount in the account.
Vanguard Financial
Advisor Services™
All investing is subject to risk, including the possible loss of the money you invest.
Withdrawals from a Roth IRA are tax free if you are over age 59 1/2 and have held the account for at least
five years; withdrawals taken prior to age 59 1/2 or five years may be subject to ordinary income tax or a
10% federal penalty tax or both.
This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor
about your individual situation.
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