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Time to recharacterize Roth IRA contributions
Old 02-05-2009, 10:13 PM   #1
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Time to recharacterize Roth IRA contributions

I haven't seen anything posted on this yet, so I'll throw out an idea.

Consider recharacterizing your 2008 Roth IRA contributions to deductible Traditional IRA contributions to maximize tax savings.

I contributed a total of $10,000 to Roth IRA's in January 2008 for DW and me. Now they are only worth around $6000. We have low enough adjusted gross income to allow us to recharacterize the IRA contributions from Roth to Traditional. The AGI limits are $85,000 for a full $10,000 deductibility, and the amount deductible decreases up to a $105,000 AGI. These are dollar amounts for married taxpayers.

My reasoning is that I get a tax deduction of $10,000 for IRA contributions that amount to only $6000 today. I'm in the 22% state/federal bracket, so I pay $2200 less tax for a $6000 traditional IRA contribution. So when I withdraw this in the future, yes it will be taxed at ordinary income rates, but I also have $2200 in my hand to invest today.

I didn't do a net present value calculation on this, but rather took this decision on the "bird in hand is better than two in the bush" rationale. A similar rationale would apply if I made traditional IRA contributions and then they doubled within the allowable recharacterization period - ie went from $10,000 to $20,000. I could then recharacterize this $20,000 to Roth IRA and have effectively made $20,000 in roth contributions in one year, and only forfeited $2200 in tax savings.

Anyone else doing this?
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Old 02-05-2009, 10:22 PM   #2
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I thought recharacterizing was taking a Roth that had been converted from a traditional IRA and turning it back into a traditional IRA. I hadn't considered just converting from a Roth to a traditional. Is it legal? Probably so. I guess it would save you a few bucks in taxes this year. Can you then re-convert to a Roth at a later date?
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Old 02-06-2009, 05:32 AM   #3
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I am talking off the top of my head here, but I believe it is the value at point of re-characterization, $6,000 in your example. Kind of logical (although taxes are anything but) if you were transferring to a ROTH the $10,000 what is now worth $6,000 would be a $6,000 transfer.
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Old 02-06-2009, 06:51 AM   #4
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I drip it into my Roth throughout the year, so I am not going to recharacterize, but would definitely consider it if I dropped it all in back in Jan of 2008. Especially since it fell so much in the year.

Another consideration for once your money is recharacterized back into your Trad IRA is that in 2010(at least this is how I think the law is now) you can convert to Roth any amount and spread the tax bite over 2 years(I think that is the #years), REGARDLESS of income.

I like your approach and am considering actually going the other direction of converting some $ to Roth since the account value in the Trad IRA is pretty low, resulting in fewer taxes.
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Old 02-06-2009, 07:45 AM   #5
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Quote:
Originally Posted by BigBob View Post
I like your approach and am considering actually going the other direction of converting some $ to Roth since the account value in the Trad IRA is pretty low, resulting in fewer taxes.
This is the action most "experts" are recommending. The logic here is you pay less taxes to covert assets (down 40%) that will be worth more when the market recovers.
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Old 02-06-2009, 02:48 PM   #6
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Quote:
Originally Posted by OAG View Post
I am talking off the top of my head here, but I believe it is the value at point of re-characterization, $6,000 in your example. Kind of logical (although taxes are anything but) if you were transferring to a ROTH the $10,000 what is now worth $6,000 would be a $6,000 transfer.
That is not how it works per my understanding. The recharacterization is like a "do-over" or mulligan. It is as if I am contributing the full 2008 contribution ($5000 each) into the Traditional today, except the actual cash value is only whatever is left. I get the full deduction, and to the IRS it looks just like I contributed $5000 each to the Trad IRA (except you do have to list the "distribution" as they call it in the margin of your tax form and then include a letter of explanation which I just save from year to year).

I just got a status update from Vanguard and they COMPLETELY screwed up my recharacterization and DW's recharacterization in the exact same manner. And they were bordering on rude during the phone call (not accommodating may be a better way of putting it). They refused to admit that mistakes were made. They refused to acknowledge that they accidentally transfered my 2007 contributions (can't touch those any longer from the IRS's point of view). After a 41 minute phone call, they refused to also review my wife's IRA's with the EXACT same set of facts and errors. They even refused when I offered to conference call her in so she could authorize them to investigate the same situation. They did promise to send a request for an investigation.

This is almost enough to make this particular Voyager client fill out a transfer of assets request form. Not that they would process that form correctly either.

I'm just glad I recharacterized earlier rather than later. Hopefully I can get this resolved before February 28 when Fidelity gets me my "corrected" 1099's.

As financedude says, at least I saved a few basis points on expense, right?

On the bright side, it's Friday (the last day of the workweek for those already ER'd).
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Old 02-06-2009, 02:50 PM   #7
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Originally Posted by Bikerdude View Post
This is the action most "experts" are recommending. The logic here is you pay less taxes to covert assets (down 40%) that will be worth more when the market recovers.
I may do this once my recharacterization gets straightened out. Get a tax deduction on $10,000 in contributions, then convert and pay taxes on $6000.

How sweet the tax code is.
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