Financial markets were closed on New Year’s Day but I was eager to put in my IRA contribution for the new year. Because my income is likely over the limit for a direct contribution to a Roth IRA, I have to first contribute to a traditional IRA and then convert to Roth later, in a move known as a backdoor Roth.
I have my IRAs with Vanguard. A bug on the Vanguard website made my contribution more complicated but it also gave me an opportunity to demonstrate how to recharacterize an IRA contribution.
When you log in to Vanguard, you first see a list of your accounts and their balances, with a link to each account. However, no matter which account you click on, the next screen always puts your position at the first account. If you’d like to transact in a different account you will have to scroll down and find the right account.
This bug tricked me. My Roth IRA is listed first, before my Traditional IRA. I guess that’s because the letter R comes before the letter T in the alphabet. Even though I clicked on the Traditional IRA in the list on the first page, I was positioned at the Roth IRA on the second page. I then went along and ended up entering the contribution to the Roth IRA.
I realized the mistake soon after I finished entering the contribution. Even though the order wouldn’t be executed until the next day because it was New Year’s Day, there was no way to cancel the order (I’m on the classic “mutual funds only” platform, not the new brokerage account platform). Vanguard doesn’t have customer service on holidays or weekends. Even if I could call customer service, from my past experience, customer service can’t cancel a pending order either. The final order entry page warns that any order entered can’t be canceled or changed, and they really mean it.
My only choice was to wait until the contribution goes into the Roth IRA and then recharacterize the contribution as a contribution to the Traditional IRA. The new tax law disallowed recharacterizing a Roth conversion. Recharacterizing a contribution is still allowed.
If you also find yourself in this situation, here’s how to recharacterize an IRA contribution at Vanguard.
Vanguard used to have an online form you can fill out for the recharacterization request. I guess because too many people fill out that from wrong, now Vanguard removed that online form. They still have a paper form but it’s not listed anywhere in the Forms section on their website. They want you to call their retirement specialists and they can recharacterize for you over the phone.
How to request a recharacterization
Start by calling us at 800-205-6189—one of our experienced retirement specialists may be able to complete your recharacterization in a single phone call.
If it can’t be done over the phone, you’ll be instructed to complete and return this form instead:
Source: IRA recharacterizations, vanguard.com
I’m wary of recharacterizing over the phone. It’s too easy to misunderstand each other when you are giving instructions verbally. You can say something wrong because you misunderstood the rep. The rep can do it wrong because they misunderstood you. If you said convert when you meant recharacterize, the transaction can’t be undone afterwards. It’s much better to have your intention clearly documented in writing on a paper form. If you have questions about the paper form you can ask them, but in the end you are still better off if you fill out the paper form and mail it in.
Lessons learned: when you use the Vanguard website, double check which account you are entering the transaction in. It may not be the one you expected. If you contributed to the wrong IRA, you still have one chance to fix it.
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Ray says
Hello Harry, I have enjoyed your blog, and emails, for a long time. Concerning Vanguard and the access to a particular account from the accounts home page, I tested that myself and found selecting a particular account (we have 5) did indeed take me directly to the account I wanted. Still, as you suggested, attention to detail is paramount.
Perhaps the experience is browser dependent. I use Firefox.
Harry Sit says
Ray – Thank you for testing it. It’s good to know it doesn’t affect everyone. I use Chrome on Windows, which is probably the most common setup. Two other readers emailed me saying the same thing happened to them. I hope Vanguard will fix it or simply make it possible to cancel a pending order.
Clint says
I too use Firefox but I regularly encounter Harry’s bug on Vanguard. The most recent occasion was yesterday when I wanted to take part of my RMD for 2018. It’s been that way for a long time. It would be better if they omitted the first step of selecting which account you want and just go directly to all of them.
Marty says
As a 30+ year customer of Vanguard (the first mutual fund company I opened an account with), I have increasingly become very disappointed with them. I opened an account with Fidelity because they were the custodians of my 401k plan and it was easy to transfer it when I decided to roll it into an IRA. Since then I have been transferring many assets over to Fidelity. Their website and things you can do onlne, superb customer service which I have never not be able to call and range of products is better than and just as low cost as Vanguard, Schwab and TRowe Price. Give them a try. There are just too many hiccups with Vanguard that keep popping up. They are no longer the company they once were.
Scott R says
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Scott R says
Am I the only one who finds it somewhat amusing/hypocritical that this is Harry’s first post after taking the moral high ground in his “Paying Taxes: By The Book Or Catch Me” post/comments?
The current tax law does not allow people over a certain income level to contribute to a Roth IRA, which makes it pretty clear what the intent was/is. Using the “backdoor” approach, you can contribute money to a traditional IRA, then transfer the money to a Roth IRA, thereby getting around the intent of that tax law.
How can you view utilizing a backdoor Roth as OK, while criticizing others who test out other vague aspects of certain tax policies (e.g., pre-paying/deducting property taxes)?
Harry Sit says
It’s not vague. People who fit in Example 1 in the IRS advisory are in the clear. People who fit in Example 2 but still choose to deduct it would make up rules on their own. In this case both the contribution and the conversion are clearly allowed. I don’t make up my own rules against explicit guidance from the IRS. I don’t convert the next day. I invest the money right away in the Traditional IRA. I let the money grow in the Traditional IRA. In fact I still haven’t converted the money I contributed in January 2017. When I convert, I will pay tax on the substantial earnings the money made last year. That’s by the book.
Larry says
Harry, why do you wait to execute the backdoor Roth contribution? There isn’t anything I am aware of to prevent the transfer from the traditional IRA to the Roth as soon as the funds clear. That’s how I do it. By waiting you are, unnecessarily I think, generating taxable gain.
Larry says
Scott R,
I too thought Harry might have gone a bit far in suggesting we weren’t entitled to tax avoidance, as I commented at the time, but I think he is right about this one. Congress was well aware of the backdoor Roth and, after consideration, declined to eliminate it in the most recent tax reform legislation. It is now accepted as appropriate by the IRS, tax court, and Congress. Perhaps grey once upon a time, it is no longer.
Harry Sit says
Larry – To be clear, I’m not against legit tax avoidance. I’m only against not following the rules as published. “You said the property tax has to be already assessed. Mine isn’t assessed but I’m going to prepay and deduct anyway.” That’s not cool.
I wait before converting because I don’t mind paying taxes on the earnings. I don’t see the taxes as wasted. Relative to many years of tax free growth, paying taxes on one year of earnings isn’t a big deal in the grand scheme. It may be unnecessary. I’m OK with not wringing out the last drop. With the way I do it, there is no way I would be accused of getting around something.
Larry says
Harry, you are attributing someone else’s argument to me. I merely quoted Judge Learned Hand. For the record, I neither argued for prepaying property taxes, nor did I actually do it.
The better example in my case is that, for a backdoor Roth, I would immediately transfer from a traditional to Roth IRA to avoid taxes on the gain in the interim, which is pure tax avoidance, and you would leave the funds in the traditional to accrue gain and then pay the tax later when you converted. I think are conflating a public goods argument with a legal argument. It may be that the government could use more tax revenue, but there is no legal or moral reason to pay more taxes than you owe.
Scott R says
I believe the reason for waiting more than a day (in Harry’s case, I believe he initially recommended doing the conversion every other year) was to make it all look more legit (i.e., like a true conversion), rather than as simply “getting around” the intent of the tax law (i.e., if you have income over x amount, you can’t contribute directly to a Roth IRA). That’s why I still find Harry’s perspective on this odd.
It’s true that the latest tax law didn’t close the backdoor loophole. It’s also true that they didn’t remove the restriction on the contributing directly to a Roth if your income is over x amount.
Anyway, it’s not my intent to be a thorn in Harry’s side…I’m in the same boat and I’ve followed Harry’s instructions on this myself (I contribute every year, convert every odd year, and don’t worry about the gains being taxed).
FWIW, the first year I did this, the timing/market was such that my initial contribution actually suffered a *loss* by the time I went to convert it. So, it’s not a given that you’ll have gains that would be taxed. I believe the amount of the loss got carried over to the following year’s “basis” line on the 8606, so it effectively serves as a “credit” that carried forward to decrease gains I may have gotten that next year. Or something like that.
Harry Sit says
Larry – I wasn’t attributing that argument to you. I was just differentiating legal tax avoidance from playing dumb. Converting the next day may still be perfectly legal. I’m not able to determine that and I don’t have to make that determination when I don’t mind just paying taxes on the earnings.
Scott – Restricting direct contributions and allowing conversions are not in conflict with each other. By waiting and paying taxes on the earnings we are following both the letter and the spirit of the law.
Larry says
I’m still quite satisfied with Vanguard, and use them exclusively. This is in part because my company has all my various retirement accounts there. But generally I appreciate the concept, the offerings, and the service. All that said, there are still glitches, as Harry calls them. I encountered two yesterday. First, due to an update on their end, I had to delete and re-add my bank information in order to make an IRA contribution. Then, more annoyingly, I tried an online form (in this case limited agency for spouse). The form would not work with any of my browsers (Edge, Firefox, or Safari). Vanguard says they have to be updated to specific versions. But I updated them and still no joy. Oh well, a letter now and then is no reason to leave an otherwise great company.
ABC says
“Because my income is likely over the limit for a direct contribution to a Roth IRA, I have to first contribute to a traditional IRA”
If you have a 401k by work and want to contribute to a traditional IRA, isn’t the deduction limit lower on a traditional IRA compared to the qualification for a Roth IRA?
https://www.fidelity.com/retirement-ira/contribution-limits-deadlines
Harry Sit says
It is but I’m not talking a deduction.
Bill says
Hi,
I have a tax question regarding my backdoor approach, here’s the situation:
I have been contributing for a Roth for ~3 years. This past year, 2017 I realized my income was too high to contribute so I took advantage of the backdoor approach. In Feb 2017 I opened a Traditional IRA, using money from my Roth, ~$4,000. This was labeled as a recharacterization. Then, throughout 2017 I contributed an additional ~$4,000 to my Traditional (and converted every month to my Roth). Now, at the end of the year as I am preparing my return, Vanguard has sent me a 1099-R that appears as if I contributed ~8,000 to the Traditional, which as I know is above the $5,500 legal limit.
Here’s my question: Does the initial $4,000 recharacterization count as a contribution? When my tax return asks how much nondeductible contributions did I pay, should I put the remaining ~$4,000 or the entire ~$8,00?
Please advice,
Bill
Harry Sit says
It’s not clear what was the first $4,000 you recharacterized in February 2017. Was it contribution you made to your Roth IRA? If so, which year was the contribution for, 2016 or 2017? If it was for 2017 then you indeed contributed too much. If it was for 2016 you should’ve done something on your 2016 tax return. The ~$4,000 that moved from your Roth IRA to your Traditional IRA included both the original contribution and earnings. You need to know the breakdown.
AWhite says
I’ve had a great experience with Vanguard as well. I made this very same mistake and simply called them on the phone. They were able to recharacterize it for me in less than 3 minutes. Easy!
Dave says
Thanks everyone. I contributed more than $5,500 in both 2016 and 2017. However, it seems like I can file a 5498 form which allows me to say that I contributed excess money and I will be taxed on it.
This seems to clear up the issue. Would you agree?
Harry Sit says
It’s not a one-time deal. If you don’t remove the excess or have the excess count against a later year, you will keep paying tax on the excess every year forever.
Dave says
So, for instance. In 2016, I contributed $7,000 to my Roth. Based on my income, I wasn’t allowed to contribute anything. However, also in 2016 I opened a Traditional IRA, and to establish this account I used funds from my Roth, and “recharacterized” $4,000. Wouldn’t that be considered “removing the excess contribution for 2016?” What other way do I remove it?
Dave says
Thanks for all of your comments, I spoke with my retirement advisor and got it all squared away.
Evan says
Harry, is it just me or has the link to this form disappeared? Under “Additional forms – Recharacterization” there is only the “Abandonment Request Form”. Not what I want!
I’ve got the non-Docusign version here, but I was hoping not to have to mail it in: http://vanguard.com/forms/s220.pdf
Harry Sit says
Apparently Vanguard now prefers that you call and recharacterize over the phone.
“How to request a recharacterization
Start by calling us at 800-205-6189—one of our experienced retirement specialists may be able to complete your recharacterization in a single phone call.
If it can’t be done over the phone, you’ll be instructed to complete and return this form instead: … …”
https://investor.vanguard.com/ira/roth-recharacterization
I guess too many people fill out that DocuSign form wrong when unguided. You can call them and have them walk you through the pdf form. In the end I would still prefer to fill out the form and have a clear paper trail for what I want done, even if I have to mail it in. If the recharacterization is done verbally you have too many chances for misunderstanding and finger-pointing when it’s not done correctly.
Thank you for bringing this to my attention. I will update the post shortly.
bws92082 says
Hi Harry. In 2021, I recharacterized my Roth IRA to Traditional at Vanguard, but now, in early 2022, I realize I made mistake because will pay no income tax in 2021 due to maxing out my (traditional) 401k. Vanguard says you can’t reverse a recharacterization. Do I have any options to mitigate this error?
Harry Sit says
You can ask your IRA custodian to process a return of your contribution before filing your tax return. Earnings on the contribution must come out, are taxable, and subject to the 10% penalty (only the earnings, not the original contribution). See IRS Publication 590-A, page 30.
bws92082 says
Thx for the info. As it turns out, I was mistaken about my tax return results so I won’t need to undo anything after all.