Traditional and Roth IRA: Recharacterize vs Convert

When it comes to doing something to a Traditional or Roth IRA, recharacterize and convert seem to be two similar concepts but they actually have very different meaning. They both involve change. When you recharacterize, you are changing something. When you convert, you are also changing something. Don’t confuse the two though. If you tell your IRA custodian to recharacterize when you meant convert, you may end up paying tax penalties.

I thought long and hard how to distinguish the two. Here’s what I came up with:

Convert operates on a static balance, a pile of money, if you will. The pile sits in a Traditional IRA. You move it to a Roth IRA. That’s converting. It’s a one-way street. You can’t convert money in a Roth IRA to a Traditional IRA. Because convert operates on a static balance, you can convert whenever you want. The money is always there for you to convert.

Recharacterize operates on an action. You can recharacterize a contribution, which is an action; or you can recharacterize a conversion, which is also an action. Because it operates an action, you have a deadline to affect the action. If you don’t recharacterize before the deadline, the original action becomes permanent.

When you recharacterize, you are saying originally I did X, but on second thought never mind, I want to do Y. If you contributed to Traditional IRA but you had second thought, within a deadline you can recharacterize the contribution as a contribution to a Roth IRA (if you otherwise are eligible to contribute). It also goes the other way: if you contributed to Roth IRA but you had second thought, within a deadline you can recharacterize the contribution as a contribution to a Traditional IRA. If you converted from Traditional to Roth but you had second thought, within a deadline you can recharacterize and undo the conversion.

Say you made non-deductible contribution to a Traditional IRA because your income is too high for contributing to a Roth IRA. If instead of converting from that Traditional IRA to Roth IRA, you said recharacterize, now you are in trouble. Your IRA custodian doesn’t know you aren’t eligible to contribute to Roth to begin with. They will do as you say. Come tax time, your recharacterized contribution will trigger a penalty.

Don’t confuse convert and recharacterize. The letter ‘a’ in recharacterize stands for action. Convert operates on a pile of money; there’s no deadline. Recharacterize operates on an action; it has a deadline.

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Comments

  1. Harry says

    LOL. I searched for “recharacterize” on Flickr. Understandably nothing came up. I then searched for “convert.” The convertible loosely relates. It says you can drive a convertible to that beautiful mountain when you convert your traditional accounts at zero or low tax rate after you retire.

    • Girish C says

      Regarding your comment “Say you made non-deductible contribution to a Traditional IRA because your income is too high for contributing to a Roth IRA.” I did this in 2014 and then converted the full amount of $5500 from my Traditional IRA to a Roth IRA. As soon as I report the distribution in form 1099R from my financial institution, my tax liability goes up in Turbo Tax. Apparently, I have to do something under Deductions to get Turbo Tax to file form 8606. Any pointers here?

  2. Jeff says

    Very informative blog. My income came in higher than expected in 2014, and I wound up over the phase-out for Roth. I have yet to withdraw the money from the Roth, is there any opportunity for me to “recharacterize” this 2014 Roth contribution to my traditional IRA as a nondeductible contribution at this late date (12/9/15). Since I am beyond the extended tax return deadline, could I amend my 2014 return showing these recharacterized amounts? Or have I blown the timing completely. Trying to set myself up to take advantage of the Backdoor Roth option.

    • Harry Sit says

      Jeff – The deadline to recharacterize for 2014 contribution already passed. You owe a 6% penalty for the excess contribution for 2014. If you don’t withdraw before 12/31/2015 you will owe a 6% penalty again for 2015 and every year thereafter until you withdraw. See Correcting an Excess Roth IRA Contribution.

  3. Partha says

    I made this exact mistake after talking to Fidelity. I contributed to Traditional IRA and then instead of converting to Roth IRA, I recharacterized the contributions to Roth IRA in 2015. Now I understand that the best way to correct this is to recharacterize the full Roth IRA holdings to Traditional IRA, correct? How long after I recharacterize back to Traditional IRA, should I wait before I convert to Roth IRA?

    • Harry Sit says

      Partha – I’m not sure whether or how you can recharacterize the contribution again. Please contact Fidelity about it. There’s no waiting period for converting after recharacterizing. When you recharacterize, it’s as if you contributed to the traditional IRA all along. Sufficient time already passed since then.

  4. Leo says

    Hi Harry, I have two questions regarding Recharacterize:

    1. If I recharacterized from Roth IRA (contributed in 2014 for tax year 2014) to Non-deductible Traditional IRA in Mar. 2015. Is the tax form 8606 for Tax year 2014 exactly the same as if I contributed to the T-IRA in 2014 for 2014?

    2. After the recharacterization (which is $6100, including $600 gain when the fund stayed in Roth IRA), I did a convertion to Roth IRA in 2015. Now I am filing Form 8606 for Tax year 2015. It looks like I have to report $5500 in line 2 as the total T-IRA base, therefore the $600 gain become taxable, even though it is earned when the fund stays in Roth IRA. Is this correct?

    3. Is there any time limit between recharacterization and convertion? I.e., Theoretically can I recharacterize the first day, and then convert back to Roth IRA the 2nd day? IRS Pub 590 seems to have a 30 days rule, but I’m not sure if it applies to this case.

    Thank you!

    • Harry Sit says

      1) and 2) are both correct. No time limit in your case when you recharacterized a contribution. The 30-day applies when you recharacterize a conversion.

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