What is Recharacterization in IRA Contributions?
Recharacterization allows you to change the type of an IRA contribution within certain deadlines, providing flexibility in your retirement planning. Here, we explore the two main IRA strategies:
- A contribution to an IRA can be recharacterized as a contribution to a different type of IRA. For instance, a Roth IRA contribution can be changed to a traditional IRA contribution or vice versa, subject to specific deadlines.
- Previously, a Roth IRA conversion could also be undone. However, this is no longer permitted under the Tax Cuts and Jobs Act. Today, Roth IRA conversions are permanent and irrevocable.
Key Takeaways
- You can recharacterize an IRA contribution to a different type of IRA, as long as you meet the applicable deadlines.
- Reversing a Roth IRA conversion to a traditional IRA is no longer allowed since the implementation of the Tax Cuts and Jobs Act.
- Roth IRA conversions are permanent—once done, they cannot be undone.
How Recharacterization Works
With recharacterization, a contribution to one type of IRA can be categorized as a contribution to another type of IRA. For example, you contributed $6,000 to your Roth IRA but decide to recharacterize it as $6,000 in a traditional IRA. Note that the annual contribution limit is $6,000 for 2022 and increases to $6,500 for 2023. However, employer contributions under simplified employee pension (SEP) or Savings Incentive Match Plan for Employees (SIMPLE) IRAs can’t be recharacterized.
Recharacterization offers the ability to adjust if you made an incorrect contribution or if circumstances change, such as income surpassing Roth IRA contribution limits.
To recharacterize a contribution, you need to act before the due date of your federal income tax return (including extensions). This lets you ignore the initial contribution to the first IRA by attributing it to the second IRA for the same tax year.
Steps to Recharacterize an IRA Contribution
- Use an existing IRA or create a new one to accept the recharacterized funds.
- Notify your financial institution(s) about the intent to recharacterize. If the same provider manages both IRAs, one notification suffices. Otherwise, inform both the custodian holding the current contribution and the institution that will accept the recharacterized contribution.
- You may proceed online or through your IRA custodian’s standard process.
- Report the recharacterization on your tax return for the original contribution year using IRS Form 8606.
Allocating Earnings When Recharacterizing Contributions
Any earnings or losses associated with the original funds must also be adjusted when recharacterizing. If illustrating with an entirely new IRA consisting only of the recent contribution and its growth, this is known as a full recharacterization. For partial recharacterizations, calculate the portion of earnings tied to the original funds or have your IRA provider handle the calculation.
IRA Contribution Limits and Guidelines
For 2022, you may contribute up to $6,000 to your Roth and traditional IRAs combined. If aged 50 or older, you can make an additional $1,000 catch-up contribution. Limits rise to $6,500 (or $7,500 with catch-up) in 2023. Note that these totals must account for contributions across all your IRAs. So contributing $4,000 to a traditional IRA caps a Roth IRA contribution to $2,000 within the same year.
Additional limits apply to Roth IRAs based on your modified adjusted gross income (MAGI) and filing status. For instance, in 2022, those married filing jointly can’t contribute to Roth IRAs with a MAGI of $214,000 or higher ($228,000 for 2023).
By understanding and utilizing recharacterization, you gain flexibility and control over your retirement planning, ensuring your contributions align with long-term financial goals.
Related Terms: retirement accounts, tax planning, retirement savings, IRA conversion.
References
- Internal Revenue Service. “IRA FAQs”.
- Internal Revenue Service. “401(k) Limit Increases to $22,500 for 2023, IRA Limit Rises to $6,500”.
- Internal Revenue Service. “Instructions for Form 8606 (2021)”.
- Internal Revenue Service. “Retirement Topics — IRA Contribution Limits”.
