January 28, 2019

New Tax Reforms Puts an End to Recharacterization of Roth IRA Conversions

Both traditional IRAs and Roth IRAs allow your investment earnings to grow each year without being taxed. However, though the retirement plans are generally considered quite similar, key differences do exist. One important difference is that Roth IRAs provide you with tax-free income during retirement. Another key difference is that with traditional IRAs, you get a deduction for contributions made to the plan that year.

One way of getting money into a Roth IRA is through a conversion, for example having contributions from traditional IRAs be converted to the Roth IRA. Under the old rules, investors were allowed to recharacterize or undo the conversion if a stock market dip after the conversion meant they would be paying income tax based on a higher value for the assets than they were worth after the market decline. After recharacterizing, investors would typically convert again later on when their tax would be lower.

Under the new rules, investors are no longer allowed to recharacterize or undo a Roth IRA conversion that occurred after Dec. 31, 2017. By getting rid of this loophole, the IRS is trying to minimize the amount of money moved from tax-deferred accounts to tax-free accounts, which is estimated to be in the neighborhood of $385 million.