Tax Reform for Individuals: Roth Recharacterizations

Converting a traditional IRA to a Roth IRA may make sense for your retirement strategy depending on your tax situation. For example, you might want to pay tax on contributions in your current tax bracket if you expect to be in a higher bracket when you retire. Before tax reform, you could later decide to recharacterize back to a traditional IRA if your tax situation changed. Below we discuss the changes going forward, how it compares to the previous law and how individuals will be impacted by the change.

New Law

Under the Tax Cuts and Jobs Act (TCJA), an individual can continue to make a conversion contribution to a Roth IRA from a traditional IRA, but it can’t be undone. The new law prohibits recharacterization used to unwind a Roth conversion.

Previous Law

Under the previous tax code, you could use recharacterization as a future tax planning tool. An individual taxpayer could change their traditional IRA into a Roth IRA but if the taxpayer saw benefit to switching back to a traditional IRA, such as investment return changes, they could hit the “undo” button and reverse the decision.

Impact on Individuals

The changes don’t prohibit all forms of recharacterization. For example, an individual can make a contribution during the year to a Roth IRA and, before the individual’s tax return due date, recharacterize it as a contribution to a traditional IRA. This transfer would be considered a tax-free rollover. Since you can no longer hit the “undo” button, you will want to consult your local tax professional about the advantages or disadvantages of this decision, as it is final once you have made that decision.

Contact an Anders advisor with questions on how the new tax law will affect you.