The Elimination of ROTH IRA Recharacterizations


Article written by Brian Bickett

The Tax Cuts and Jobs Act of 2017 eliminated the option to reverse (or recharacterize) ROTH IRA conversions.  This doesn’t mean that ROTH IRA conversions are dead.  The ability to reverse a specific ROTH IRA conversion was just one of the several potential benefits to the conversion process. 

IRA Basics

The ROTH IRA was officially established as part of the Taxpayer Relief Act of 1997 as an alternative to the already existing Traditional IRA in an attempt to encourage younger investors.  In the Traditional IRA, contributions were tax deductible and any withdrawals (contributions, growth and earnings) in retirement were subject to income tax.  The new ROTH IRA mirrored this by allowing the contribution of after-tax dollars and any withdrawals (contributions, growth and earnings) would be tax free after the age of 59 ½. 

The ROTH IRA also has other benefits such as the penalty-free withdrawal of contributions at any time and that investors don’t have to worry about Required Minimum Distributions (RMD’s) in their lifetime.  Another difference is that while contribution (and catch-up) limits are identical between the two, the ROTH IRA has an income limit for where allowable contributions are phased out. 

ROTH IRA Conversions

A fairly common tax planning strategy uses the flexibility of ROTH conversions to potentially minimize income taxes paid on retirement funds.  This strategy moves retirement funds from either taxable (in the case of a back-door ROTH conversion) or tax-deferred accounts into a ROTH IRA where future growth and earnings can be distributed tax-free as long as certain rules are followed.  This conversion requires paying income taxes today on any converted tax-deferred funds in exchange for the tax-free treatment of ROTH IRA distributions in the future.

This strategy is often reviewed for its potential benefits when projected RMD’s will push the investor into a higher tax bracket.  A strategic ROTH conversion can limit the income tax owed on tax-deferred funds in specific situations.  For example, say a married couple retires prior to the beginning of RMD’s and their expected taxable income (let’s use $60,000) that year puts them in the 12% income tax bracket.  Due to the size of the tax-deferred accounts, projected RMD’s will push them into the 22% income tax bracket (beginning at $77,400 in 2018).  A ROTH conversion up to the limit of the current tax bracket means that they pay 12% income tax on that $17,400 now instead of potentially paying 22% income tax in the future.  There are also other benefits, such as the future tax-free withdrawal of growth and earnings on the amount converted as well as no RMD’s required during the investor’s lifetime.

Find Your Financial Roadmap.

Brian can help you develop a roadmap to get you from where you are to where you want to go — and then put it in action, making your money work for you to avoid behavioral mistakes.

TCJA of 2017

Another potential benefit of ROTH conversions, prior to the TCJA of 2017, was the flexibility to reverse the conversion prior to the tax-filing deadline (plus extensions) for that year.  The reversal of the conversion was usually only done if the investment of the converted funds had lost value. 

In a typical ROTH conversion using the above scenario, the $17,400 needed to max out the current tax bracket would be converted from a tax-deferred account to a ROTH IRA in January.  The investment would grow throughout the year and the yearend balance of the converted account might be $18,400.  Completing the conversion at the beginning of the year was an advantage as only $17,400 was included as taxable income for the year.  Whereas if the conversion happened at the end of the year, there would have been an additional $1,000 of growth that would have been included as taxable income.

Alternatively, if the investment lost value over the course of the year, the yearend balance of the converted account might be $15,500.  Converting in January was not an advantage in this scenario and converting the lower amount in December would have resulted in less reportable income tax. 

Finally, the ROTH IRA Recharacterization!

This is where a ROTH Recharacterization made sense.  Now that it’s December and we have excellent hindsight for the year, the recharacterization option allowed the investor to reverse the original ROTH conversion from January – moving the $15,500 from a ROTH IRA back to a tax-deferred account.  The investor could then complete a new ROTH conversion in December on the $15,500 in the tax-deferred account.  Effectively reducing the amount of reportable income tax on the ROTH conversion by the amount of the difference.

While the TCJA of 2017 does eliminate the option to recharacterize a ROTH conversion, the elimination of that one feature doesn’t negate any of the other potential benefits of ROTH conversions.  It simply means there’s no longer the ability to undo it if the investment declines in value over the year.  ROTH conversions will continue to make sense for some investors, as always, depending on their individual situations. 

If you would like help planning the ride of your life, navigating the winding road of investing and the tax code, I can help guide you thru our financial planning and investment management processes – it’s what I do for a living. Click here to schedule an introductory call. 

Fee Only Financial Planning

Comprehensive Financial Planning

Develop a roadmap to get you from where you are to where you want to go and then put it in action.

Fee Only Investment Management

Hourly Financial Planning

Hire a CERTIFIED FINANCIAL PLANNERTM Professional who can provide you with one-time objective advice.

Fee Only Investment Management

Investment Management

Put your money to work for you and avoid behavioral mistakes.

Start your journey to financial freedom and peace of mind today.

Iron Mountain Financial Planning

Phone: 605 787 1255

Office Location:
910 5th Street, Suite 106
Rapid City, South Dakota 57701

Brian Bickett, CFP at Iron Mountain Financial Planning, LLC

Schedule An Introductory
Call with Brian

ADV Part 2       Privacy Policy       Site Map

Iron Mountain Financial Planning LLC (“IMFP”) is a registered investment adviser offering advisory services in the States of South Dakota and Wyoming and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by IMFP in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant to an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of IMFP, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.