A key deadline is approaching for investors who completed a Roth IRA conversion in the 2016 tax year. There is time to reverse — or recharacterize — that conversion if it is done by October 16, 2017.
Recharacterization allows investors to reverse the action and move the funds back into their traditional IRA.
Recharacterization may help save on taxes
Converting an IRA to a Roth IRA is a taxable event. Federal income taxes are due on the value of pretax contributions and any earnings.
Reversing the conversion may help some investors lessen the tax liability and avoid paying too much in taxes for an asset that has lost value. For example, if a taxpayer converted a traditional IRA valued at $100,000 during 2016 that is now worth only $80,000, he/she would still have to report the taxable income of $100,000.
A recharacterization can help 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, or restrict use of certain tax deductions and credits that may phase out at higher income levels.
Investors may choose partial recharacterization
Investors do not have to reverse the entire amount. They 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 lessen 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 advisors, discussing Roth IRA assets can lead to a deeper review of additional retirement and tax-related planning needs.
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.