Tax question about Roth recharacterizations

[SecondCor521]

Hi all,

I converted money from my traditional IRA to my Roth IRA this year. I plan to recharacterize a portion of this conversion in early 2017 in order to dial in my AGI on my 2016 taxes to exactly where I want it to be.

My question is this: May I do the recharacterization in two transactions?

I am not exactly sure how my taxes will look for this year, in part because I have a capital gain that may or may not qualify for a section 1202 exclusion, and to a lesser extent because I don't yet have access to tax software for the 2016 tax year.

I want to convert as much from my traditional to my Roth as possible as long as I don't pay taxes at higher than a 20% marginal rate. Since I'm not sure exactly what that amount will be, I have converted more than I think will be needed and I plan to recharacterize the excess once I get access to 2016 tax software and have all of my actual tax forms (1099's and such) and of course find out if my capital gain does in fact qualify for a section 1202 exclusion.

My IRAs are at Vanguard and I am assuming I will have to do an in-kind recharacterization of a whole number of mutual fund shares prior to the close of business, which, with a semi-volatile stock market, makes it somewhat dicey to get close to the right amount.

So what I am thinking I will do is do about 95% of the recharacterization, see how close I get, and then do the remaining 5% of the recharacterization in a secondary transaction a few days later.

I would think this would be OK, but the instructions for Form 8606 and Pub 590 and all of the examples I have googled so far assume a single transaction.

So to give hypothetical numbers, if I do:

10/1/2016 $40K conversion from traditional to Roth
2/1/2017 $9K recharacterization (+- associated earnings/losses) from Roth to traditional
2/5/2017 $1K recharacterization (+- associated earnings/losses) from Roth to traditional

Can I go ahead and file form 8606 and put $30K on line 16 in part II?

 

[user5027]

I am not aware of a limit on the number of recharacterizations but for your case I would do one.

As I recall I told Vanguard the dollars and not shares to convert and the dollars of the original conversion to recharacterize.

My case.
In August 2015 I told Vanguard to convert $70,000 of VTI and they converted 679.7437 shares. In April 2016 it had gained and I told Vanguard to recharacterize $17,095 (of the original $70k). They recharacterized $17,939.22 or 167.5467 shares.

If it tanks before Oct. 15 2016 I'll recharacterize the rest.

 

[SecondCor521]

Thanks. When I did the original conversion I did it online at Vanguard and they only had the option to do a whole number of shares. If I can just specify a dollar amount then I should be able to do it in one.

 

[Animorph]

I've only used Fidelity for recharacterizations. I've recharacterized multiple accounts, most fully but always one partially, and not all on the same day or year. But never twice from the same Roth conversion. I always recharacterize a precise dollar amount (which applies to the converted amount, not the current value) and Fidelity calculates the number of shares (and partial shares) to transfer, so I haven't had to deal with whole shares. That restriction seems to come from Vanguard (unless these are stock or ETF shares?).

I don't know of any tax reason why you couldn't recharacterize twice from the same account. All the restrictions seem to come after that, when you have to wait 30 days or to the end of the year before Roth converting those shares again.

Unless you need to limit AGI to avoid a tax cliff, paying higher taxes on $100 or missing the chance to convert an extra $100 is probably not not a big enough impact to merit two recharacterizations.

I use TurboTax, so I don't always see the tax forms. I believe the forms list total Roth conversions and total recharacterizations as two or three separate numbers. I always have to fill out a description of each recharacterization with amount and date. That should match the paperwork that eventually comes from the brokerage.

 

[pb4uski]

I don't see what doing more than one recharacterization does for you, but I think you can do more than one.

I wait until my return is complete and then recharacterize the dollar amount of any excess over the top of the 15% tax bracket.

 

[SecondCor521]

I should just call Vanguard and find out if they can recharacterize a fractional number of shares. I don't see why they wouldn't, except that the online form for the original conversion only permitted whole numbers of shares, and did not permit me to specify a dollar amount.

As for why I might want to do this, here's the reasoning/back story:

1. My capital gain that may or may not qualify for a section 1202 exclusion was relatively large.
2. Because of (1) and wanting to ensure I had converted enough, and figuring it didn't matter if the shares sat around in my traditional or Roth, I converted way more than enough. I probably converted about $20K more than I needed to.
3. I assume that since I was only able to convert a whole number of shares, I would only be able to recharacterize a whole number of shares. Also I assume that I have to fill out the recharacterization and submit it while the market is open and will get whatever closing price is that day.
4. Because of (3), I could be off by 0.5%.
5. Because of (2) and (3), this works out to $100 ($20K * 0.5%).
6. Because of (5), I would want to under-recharacterize by a little to make sure I didn't over-recharacterize.
7. Because of (7), I would probably end up under-recharacterizing by a few hundred dollars, say $250.
8. Since I'm dealing in VTSAX, with a share price of ~$50, after my large recharacterization, I would want to try to get the additional $250 from (7) recharacterized also.
9. A second recharacterization of, say, 5 shares, would have a smaller variance ($250 * 0.5% = $1.25) and thus allow me to dial it in more.

But again, all of the above complicated overthinking plus making assumptions rather than just calling Vanguard is why I don't get much done.

I'm not near any cliff as far as I know, but I just want to dial in my taxes to the exact point where I start paying at a marginal rate above 20%. Animorph is right, it really doesn't matter too much, but this is the first time in my life I've been able to try to manipulate my income, and I'm kind of a perfectionist, so I'm a little obsessed about it.

Thanks.

 

[Retire2017]

Another Roth IRA related question

Hi, I have a Roth IRA and a 401K questions, but don't know how to start a new thread. So I posted here, hope IP doesn't mind.

Here you go:

1: Can I contribute the maximum (24k) to 401k if I retire early next year?
2: Then can I convert the 24k later in the year to a Roth IRA?

Thanks.

 

[pb4uski]

1. Yes, if you plan allows and you earn at least the max in that year. I assume that you mean that you want to contribute the max in the year that you retire even though you are not working a full year.

2. Yes, if your plan allows. See https://investor.vanguard.com/401k-rollover/options

 

[bingybear]

Hi, I have a Roth IRA and a 401K questions, but don't know how to start a new thread. So I posted here, hope IP doesn't mind.

Here you go:

1: Can I contribute the maximum (24k) to 401k if I retire early next year?
2: Then can I convert the 24k later in the year to a Roth IRA?

Thanks.

1. Yes, if you plan allows and you earn at least the max in that year. I assume that you mean that you want to contribute the max in the year that you retire even though you are not working a full year.

2. Yes, if your plan allows. See https://investor.vanguard.com/401k-rollover/options

add one condition, you are 50 or older.

 

[kaneohe]

Hi, I have a Roth IRA and a 401K questions, but don't know how to start a new thread.

To start a new thread if in early-retirement.org page, click "today's posts"
or "new posts" in menu bar at top. That should bring up a list of posts with
the various forum names in last column. Click on the forum list name you want to post in which should bring up a list of posts in that forum. There should be a box called "new thread" on upper left side of that list. Click there to start the new thread.

 

[SecondCor521]

IP here; I don't mind.

Also, Retire2016, if you do actually retire, you should be able to roll your 401(k) from your employer to a traditional IRA (at Vanguard or Fidelity or whereever) and thence to a Roth IRA. I think there may be newer law that says you can go directly from a 401(k) to a Roth, but I'm not certain about that.

You of course know that the amount of the conversion when you move it to a Roth will be added to your taxable income (assuming your contributions to your 401k were tax-deductible; they probably were).

The 50-or-over comment applies to the maximum amount of the contribution; if you're under 50 you can only contribute $18K or maybe it is $18.5K. The rest of the responses are correct regardless of your age. Meaning that people under 50 can contribute the max to their 401k and then retire and move their money to a Roth IRA (me, for example - I am only 47).

 

[Retire2017]

Thanks everyone for your help. I got it. Yes, I am over 50 (will be 56 next year).

 

[Sandy & Shirley]

I've only used Fidelity for recharacterizations. I've recharacterized multiple accounts, most fully but always one partially, and not all on the same day or year. But never twice from the same Roth conversion. …

Multiple accounts is the key for recharacterizations so I want to explain it in a bit more detail.

You want to convert each symbol into its own separate Roth account to insure the best results on a future recharacterization. My broker is Fidelity and the process is relatively simple as I remember it:

Top of screen, Open an account, next to Roth IRA, open online, etc. Then hit Customize and give the account a new nickname.

For example, you have $10,000 of ABC and $10,000 of XYZ. If you create just one Roth account for both symbols and ABC goes up 20% while XYZ loses 10%, at recharacterization time the single account has $12,000 of ABC and $9,000 of XYZ, a total of $21,000 which is a 5% gain for “the account” from the $20,000 initial conversions.

If you then want to recharacterize the XYZ your account will have to be debited $10,000, initial conversion amount you are undoing, plus $500, the overall gain of “the account”. Bottom line it cost your $10,500 to reduce your annual conversion amount from $20,000 to $10,000.

If you created two new accounts and converted ABC into RothABC and XYZ into RothXYZ, then “the account” RothXYZ would have had an overall loss of 10% and undoing the XYZ conversions would have only cost you $9,000.

The actual way this is done is to take the value of the account at the time you did the initial conversion and compare it to the value of the account at the time of recharacterization. This allows you to do whatever you want within the account, but also mixes everything together as it applies to individual symbols. It gets very confusing if you convert into your single existing Roth account because the gains and losses for every symbol in that account will modify the cost of recharacterization.

 

[Newventurer]

Thanks everyone for your help. I got it. Yes, I am over 50 (will be 56 next year).

If you haven't already, you may also want to consider why it may be a good risk management move to leave assets as a 401k vs IRA. Of course flexibility and performance of investment choices is hard to overlook. Good luck.