Some of you weren’t so impressed when I drew diagrams to show that an IRA conversion doesn’t really convert the IRA itself. It only moves the money from a traditional IRA to a Roth IRA, leaving the source IRA container intact afterwards.
While you may know this all along, it’s not necessarily so obvious to others. Especially in today’s world when so much is read on the go on a small screen, a graphic illustration can work much better than just words.
With that in mind, I’m repeating the topic I covered in Traditional and Roth IRA: Recharacterize vs Convert. The key takeaway is “convert” operates on a sum of money while “recharacterize” operates on a previous action. You never recharacterize an IRA. You only recharacterize a previous action you performed to the IRA. As such, you can recharacterize two different types of actions:
- recharacterize a contribution; or
- recharacterize a conversion
Recharacterize A Contribution
When you recharacterize a contribution, you are saying you changed your mind on which type of IRA you wanted to contribute to. You make it as if you contributed to a different type of account to begin with. It can go both ways: recharacterize a traditional contribution to a Roth contribution or recharacterize a Roth contribution to a traditional contribution.
You can only recharacterize a contribution once. After you say you changed your mind, you can’t change your mind again. You can, however, recharacterize only part, but not all, of your original contribution.
When you recharacterize a traditional IRA contribution, the IRA custodian moves your contribution plus earnings from your traditional IRA to your Roth IRA.
Because recharacterizing a traditional contribution to a Roth contribution makes it as if you contributed to Roth to begin with, you must be within the income limit for contributing to a Roth IRA.
When you recharacterize a Roth IRA contribution, the IRA custodian moves your contribution plus earnings from your Roth IRA to your traditional IRA.
Recharacterizing a Roth contribution to a traditional contribution is especially useful for lowering your AGI when you qualify for a deduction. It’s also useful when you find out after the fact you exceeded the income limit for contributing to a Roth IRA.
Recharacterize A Conversion
When you recharacterize a conversion, you undo the conversion. You make it as if you didn’t convert to begin with (or didn’t convert as much). It can only go one way (Roth to traditional) because the original conversion could only go one way (traditional to Roth).
When you recharacterize a conversion, the IRA custodian moves the converted amount plus earnings from your Roth IRA back to your traditional IRA.
There’s no income limit for recharacterizing a conversion. You can recharacterize only part, but not all, of the original conversion.
Recharacterizing a conversion is useful when you realize you don’t want to pay that much tax yet on converting your IRA.