A Roth IRA conversion has a unique provision allowing investors to reverse or undo the action. The deadline to reverse — or recharacterize — a Roth IRA conversion that was completed in the 2015 tax year is October 15, 2016.
Recharacterization allows investors to reverse the action and move the funds back into their IRA.
Tax benefits of recharacterization
By reversing the conversion, some investors may lessen the tax liability and avoid paying too much in taxes for an asset that has lost value. Consider this example: If a taxpayer converted a traditional IRA valued at $100,000 during 2015 that is now worth only $80,000, he/she would still have to report the taxable income of $100,000.
A recharacterization may help investors avoid the additional tax liability associated with higher income. When a traditional IRA is converted to a Roth, income is generated. Investors may choose to recharacterize so the additional income does not move them into a different marginal tax bracket.
The process does not have to involve the entire amount. Investors can choose to reverse a portion of the account and leave the rest of the assets in the Roth.
Also, a recharacterization does not have to be the final action taken on that account. Investors can reconvert in the future. But there are time limits and penalties if rules are not followed. For more information, review Putnam’s investor education piece, “Converting a Traditional IRA to a Roth IRA.”
Recharacterization may help investors mitigate their tax bill but it can be a complex process with many considerations. It is important to consult a financial advisor or tax consultant to determine if a recharacterization is appropriate for an individual’s financial situation.
For informational purposes only. Not an investment recommendation.
This information is not meant as tax or legal advice. Please consult with the appropriate tax or legal professional regarding your particular circumstances before making any investment decisions. Putnam does not provide tax or legal advice.