Effective January 1, 2018, a conversion from a traditional IRA to a Roth IRA cannot be “recharacterized”. If an individual during 2023 converted a traditional IRA (including an SEP-IRA or a SIMPLE-IRA) to Roth IRA then the individual will not be able to recharacterize or undo the conversion. Recharacterization of a Roth IRA conversion was permitted prior to the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), which became effective January 1, 2018.
However, the TCJA did not dispose of the recharacterization of Roth IRA contributions. This column discusses recharacterization of 2023 Roth IRA contributions. Some federal employees may have made contributions to their Roth IRAs during 2023 when in fact they were not eligible to make these contributions. They therefore must recharacterize their Roth IRA contributions.
SEE ALSO:
- IRA Contributions: Types of IRAs, Eligibility Rules and Contribution Limits
- Roth IRAs May Not Be the Best Choice for Some Federal Employees, Retirees
Why Would a Roth IRA Owner Have to Recharacterize a 2023 Roth Contribution?
The reason that a Roth IRA owner would have to recharacterize a Roth IRA contribution made during 2023 is that the Roth IRA owner is not eligible to contribute to a Roth IRA for the year 2023. Not being eligible to contribute is due to one of two reasons, namely:
(1) The Roth IRA owner (or spouse, if married) did not have any “earned income” (this is a salary/wage or net self-employment income) during calendar year 2023; or
(2) The Roth IRA owner’s modified adjusted gross income (MAGI) exceeded the MAGI limits depending on the Roth IRA owner’s tax filing status. The following table summarizes the MAGI limits by tax filing status for the year 2023:
The following example illustrates how an individual made a Roth IRA contribution during 2023 and determined that she was not eligible to make a Roth IRA contribution due to above the limit MAGI.
Melanie, age 52 and single, contributed $7,500 to her Roth IRA in September 2023. After preparing her 2023 federal income tax return, Melanie determined that her 2023 MAGI was $174,500, more than the $153,000 MAGI limit for single filers for 2023. As explained below, Melanie will have to recharacterize her 2023 Roth IRA contribution.
How to Recharacterize a Roth IRA Contribution
To recharacterize a Roth IRA contribution, the contribution must be transferred from the first IRA (the Roth IRA) to a second IRA (a nondeductible traditional IRA) in a “trustee-to-trustee” transfer.
The deadline to transfer the Roth IRA to the nondeductible traditional IRA is April 15, 2024. But if the 2023 federal income tax is filed by April 15, 2024, then a six-month extension to perform the recharacterization is possible.
The following are the requirements for an individual to recharacterize a 2023 Roth IRA contribution:
• The Roth IRA owner who is recharacterizing the Roth IRA contribution must instruct the Roth IRA custodian to transfer the 2023 Roth IRA contribution (as well as any net income allocable to it) to the second (traditional) IRA.
• The Roth IRA owner who is recharacterizing the 2023 Roth IRA contribution must report the recharacterization on their 2023 federal income tax return.
• The Roth IRA owner must treat the 2023 Roth IRA contribution as being a 2023 traditional IRA contribution made on the same date during 2023 as the contribution was made to the Roth IRA.
If an individual makes a contribution to a Roth IRA and later recharacterizes some or all of the contribution to a traditional IRA, the individual needs to report the nondeductible portion of the traditional IRA contribution on IRS Form 8606 (Nondeductible IRAs) Part I, part of which is shown here:
The following chart summarizes the reporting of a recharacterization of a Roth IRA contribution:
Note that the IRS penalty for not recharacterizing a Roth IRA contribution is 6 percent of the amount of the contribution that should have been recharacterized but was not. The penalty is imposed for each year the contribution is not recharacterized.
Individuals who have problems or questions about Roth IRA contribution recharacterizations are advised to speak with a tax professional.
Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER®, Chartered Life Underwriter, Chartered Financial Consultant, Registered Health Underwriter and Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019