On my to-do list for this month: recharacterize my IRA from a Roth to traditional IRA. Why? Roth IRAs have maximum income levels where you’re eligible for this type of investment – and it’s fairly impossible to know if you’ll hit these levels earlier in the year when you’re investing. Luckily, the government realizes you might not be trying to sneak your way into a Roth for the year, and gives you to Oct 15 to fix your classifications.
Fixing the classification isn’t as easy as filling out your simple taxes on TurboTax. It gets a bit complicated. This is why I’ve been putting it off… until now.
Not only do you have to follow the rules of the firm where you invested your money in the Roth IRA to recharacterize it, you also have to refile your tax return if you already submitted it earlier in the year (see IRA website).
If you have already filed your return, you can file an amended return and subtract the amount recharacterized from the taxable amount of the rollover or conversion reported on your original return. Form 1040X, Amended U.S. Individual Income Tax Return (instructions), can be used to amend your return. Generally, for a credit or refund, you must file Form 1040X by the later of:
- three years (including extensions) after the date you filed your original return, or
- within two years after the date you paid the tax.
My Roth IRA is at Vanguard, so I will need to first go through their recharacterization process which I haven’t figured out yet. I am probably going to end up calling them to figure this out.
Have you recharacterized a Roth IRA before to a traditional IRA? Are there any gotchca’s I should be aware of?
When I realized I would be earning too much this year to qualify for a Roth IRA, I cried a little bit. Ok, that’s overly dramatic, but I have been so proud of myself for saving my pennies each year of my $20k to $50k / year income to max out my Roth IRA that I felt a little empty knowing my savings this year could not be invested in tax-free growth.
So I thought I’d do the second-best thing… open a traditional IRA and deduct the money now, pay taxes on it later. Not the best option in the world, but at least I’d get to deduct the money from my rather high single tax rate.
This morning I found out that I was completely wrong about that. I admit it’s my fault for not doing my research appropriately, but now I’m totally bummed. Apparently the income you’re allowed to have to get the benefits of a traditional IRA is LOWER than that of a Roth IRA. This makes absolutely no sense to me right now because why would anyone want to invest in a traditional IRA if you are in a low-ish tax bracket?
I guess if you do not have a retirement plan at work you are allowed to deduct up to $5k for your traditional IRA in each tax year. Funny how this is the first year of my life I will have access to a retirement plan… a 401k (no match or anything, of course, god forbid I work for a company that would match my contributions.) I signed up for it, and I am supposed to start making contributions in mid July. I wanted to max out my 401k and my IRA for the maximum deduction to reduce my AGI. But it looks like that’s not happening.
The only reason I can see a traditional IRA having some benefit is that I think I can still put up to $5k in there each year and $16.5k into the 401k and later, when I’m not making a lot of money over the year, I can convert both of those accounts to a Roth IRA and pay taxes in a lower tax bracket. Given that I obviously don’t understand tax law very well, I may be off on this logic as well. At least then I can see why a traditional IRA has some value. But as this conversion thing is fairly new – why would anyone want to open a traditional IRA? Is there ever a good reason for this?