IRA Recharacterization Rules

In 2018, American investors said goodbye to a key retirement-saving strategy: the ability to “recharacterize” Roth IRA conversions.

That’s a mouthful, so let’s start with the basics by reviewing the two types of IRAs. Traditional IRA contributions are tax-deductible (in the year in which you make the contribution), but any withdrawals you make in retirement are taxed at your ordinary income-tax rate.

The Roth IRA, meanwhile, does not provide any tax breaks for contributions; however, earnings on the account and withdrawals are generally tax-free.

There are pros and cons for each type of IRA, and sometimes people change their minds about which is best. In the past, you’ve been able to convert funds in a pre-tax IRA to a post-tax Roth IRA simply by paying tax on the converted money. Your money then grows and is not taxed at withdrawal.

Sometimes, however, people change their minds about that conversion, and the old US tax law allowed them to undo that transaction anytime up until Oct. 15 of the year following the conversion. This is called a “recharacterization.” But under current tax rules, recharacterization is not allowed.

This may make Roth conversions less attractive for many individuals. If there’s no possibility of undoing a conversion, some people may hesitate to convert.

If you are thinking of converting a traditional IRA to a Roth IRA, you may want to speak with a financial professional to determine that the conversion is right for you (or come up with another plan if it is not).