Recharacterizing a contribution - as opposed to a conversion.

[Guest Kingman]

I've done my homework and it's obvious what happens if you convert a traditional IRA to a Roth - then realize later that you're not eligible (recharacterize back to traditional).

But what if I open a Roth IRA, contribute $2,000 and then later find out that I do not qualify. Can I just cash out the contribution and gains - and pay taxes on the gains ??

Thanx in advance - Kingman

[Kathy]

Yes, pay taxes and perhaps penalties on the gains unless you satisfy one of the exceptions to the penalties. (Check with your state to see what the tax consequences are there too.)

Or, you could recharacterize (assuming you extended your tax return) your contributions to traditional IRA contributions if you want to at least defer the taxes on the earnings. However, if you do this and then want to withdraw your nondeductible contributions later, they will be treated as partially a return of your basis in the IRA and partially as a return of taxable earnings and previously deducted contributions.

Just something else to think about.

[BPickerCPA]

Two points:

One, the deadline for withdrawing excess contributions is the same date as the deadline for recharacterizations. Otherwise, the contribution is subject to a 6% excise tax.

Two, the traditional IRA would not necessarily be non-deductible. It's possible, if you are not a participant in a plan, to be eligible for a deductible IRA even though you cannot contribute to a Roth.

[Guest jsree]

i am in exactly the position described by Kingman. I had put $2000 for the year 1999 in an existing Roth IRA, where it commingled with 1998 money. Now I find out that my 1999 AGI will be too high for Roth IRA. In the meantime, I had invested part of that $2000 in some stocks, and the current value is less than $2000. My questions relate to what happens if I recharacterize. 1) Can I recharacterize the original $2000 or just the current value? 2) Can I recharacterize into an existing Traditional IRA which already has prior (deductible) contributions? 3) If funds get commingled in the Traditional IRA as described above, who keeps track of the deductible and nondeductible portions (so that I don't pay unnecessary taxes after age 59.5)? Or do I need to open a fresh Traditional IRA?

I am hoping that I don't have to open any more IRAs than I absolutely have to. Thank you very much.

[BPickerCPA]

Jsree,

You can recharacterize into a traditional IRA. You must include the applicable income which is computed on a rather complex formula since this is a commingled Roth (more than just one year's contribution). If the entire account has a gain, some of it will be applied to this year's contribution.

You can recharacterize it into an existing traditional IRA, and you need to file form 8606 (1) to reflect the recharacterization, and (2) to track basis from non deductible contributions.

[Guest jsree]

Thanks, BPickerCPA. I have one final question. Will the trustee of my IRAs

do all this figuring-out? I checked the IRS website, Publication 590, and it says that all I need to do is write a letter to the 2 trustees requesting recharacterization. But when I called customer service at the discount brokerage where I have my IRAs, I was told that they cannot help me with the math.

[BPickerCPA]

Jsree,

I guess the math is your problem. If the entire account is being recharaacterized, then the only math problem is reporting it on the 8606, which is fairly simple if you know the theory.

It's partial recharacterizations that have difficult math.