Understanding the Changes to Roth IRA Recharacterizations

1/7/2019 9:00:00 AM
The Tax Cuts and Jobs Act of 2017 includes changes to the rules governing IRAs. Specifically, the law repeals the rule permitting recharacterization of Roth IRA conversions, extends the rollover period for plan loan offset amounts, temporarily relaxes the early distribution penalty exception for medical bills, and provides tax relief relating to certain major disasters. 
While recharacterization is most commonly used to undo Roth conversions, it also applies to Roth and Traditional IRA contributions. The tax reform bill’s passage eliminated the ability to recharacterize Roth conversions for taxable years after 2017.  However, if a Roth conversion was done in 2017, the taxpayer had until October 15, 2018 to recharacterize it. The ability to recharacterize contributions remains unchanged (the recharacterization of a contribution allows you to treat a contribution made to a Traditional IRA or a Roth IRA as having been made to the other type of IRA).
Effective January 1, 2018, pursuant to the Tax Cuts and Jobs Act (Pub. L. No. 115-97), a conversion from a Traditional IRA, SEP, or SIMPLE to a Roth IRA cannot be recharacterized. The law also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as 401(k) or 403(b) plans.
A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized. For details, see “Recharacterizations” in IRS Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).
A Roth conversion is used to convert funds in a pre-tax, Traditional IRA to a post-tax Roth IRA. Taxes are paid on the money that is converted. There are good reasons to convert a Traditional IRA to a Roth IRA. However, there also may be reasons to reverse a Roth IRA conversion. For instance:
  • You lack sufficient liquid funds to pay the tax liability
  • The conversion combined with your other income has pushed you into a higher tax bracket
  • You expect your tax rate to be lower than expected in retirement, reducing the potential benefits of a Roth IRA’s tax-free distributions
  • The value of your account has declined since the conversion, which means that you would owe taxes partially on money you no longer have

Individuals should discuss and plan with their tax or financial professional before executing a conversion or qualified rollover to a Roth IRA. As these transactions can no longer be recharacterized, eliminating the possibility of avoiding the tax consequence that accompany the movement of assets to a Roth IRA, taxpayers will need to plan accordingly as “do overs” or “unwindings” are not allowed.
If you have questions, please contact Martha Muskavitch or Kyle Vaclav in the IRA Department at 262-787-6891.