What are IRA conversions and recharacterizations?

A Roth IRA conversion is when you move all or part of your traditional IRA funds to a Roth IRA.

• Contributions sitting in a traditional IRA got a tax break at the time of the contribution, and the funds get taxed when taken out in retirement. 
• Contributions to a Roth IRA are made with income that’s been taxed when earned, and doesn’t get taxed again when it’s taken out in retirement.

So with a conversion to a Roth IRA, you have to pay tax on the traditional IRA account funds getting moved to the Roth account. Then it won’t be taxed again when taken out in retirement. The conversion will be reported on IRS Form 8606, Nondeductible IRAs.

Reasons for doing this could include:

• If you expect to have a higher tax rate in retirement than the one you have when doing the conversion, or
• To avoid required minimum distributions in retirement

The easiest and safest way to do this is to ask your trustee to move the funds internally, or to another trustee if you wish. If instead you move the funds yourself, you have 60 days to complete the conversion (also called a rollover), with significant penalties if not completed on time.

You may decide you want to change your traditional IRA contribution to a Roth IRA contribution or vice versa. If you recharacterize your IRA contribution properly and before your tax return due date (including extensions), the tax effect is as though the contribution to the first IRA never happened.

Generally, you instruct the your IRA custodian to transfer the amount to a second IRA.

If you recharacterize your contribution, all these steps are required:

• The transfer amount must include any earnings or losses on the original contribution amount.
• The transfer must be made by the due date of your return (including extensions) for the tax year you made the contribution.
• Report the recharacterization on your tax return for the year during which the contribution was made.
• Use the original date of the contribution (not the date the contribution was recharacterized).

The tax consequences of the contribution are determined by the type of IRA you hold after the recharacterization. Due to the Tax Reform Act, as of 2018, recharacterization of a Roth conversion isn't allowed.