IRA Recharacterization: Retirement Guide

Contributing money to a traditional or Roth IRA can help you save money for retirement on a tax-advantaged basis. Should you make a mistake with contributions or change your mind about them, IRA recharacterization allows you to correct it. Recharacterizing an IRA allows you to switch from one contribution type to another. For example, you might change Roth IRA contributions to traditional IRA contributions or vice versa. If you’re considering recharacterization, there are some IRS rules to know. You can also talk to a financial advisor about the pros and cons of changing IRA contributions.

Understanding IRA Recharacterization

An IRA is a tax-advantaged retirement account that you can make contributions to annually, separate from any money you contribute to a 401(k) or similar workplace plan. There are two types of IRA contributions you can make: traditional or Roth.

Traditional IRAs allow you to contribute pre-tax dollars, while Roth IRAs are funded with after-tax dollars. Contributions to a traditional IRA may be tax-deductible and withdrawals are taxed as ordinary income. Roth IRAs allow for tax-free withdrawals, though you must be within certain income thresholds to contribute.

Recharacterization allows you to change your annual IRA contributions from one type to another after the fact. Why would you want to do that? There are different reasons for recharacterizing IRA contributions. For example, you might do so if you:

Contributed to a Roth IRA but later learned that you’re ineligible to do so because of your income.
Initially contributed to a traditional IRA, then realized you’re able to make Roth IRA contributions instead.
Found that your traditional IRA contributions are not tax-deductible, based on your income and the fact that you’re covered by a retirement plan at work.

Generally, you can recharacterize IRA contributions in those scenarios if you haven’t filed your tax return for the year. You can recharacterize contributions up to the regular April tax filing deadline or the October deadline if you requested an extension. The recharacterization applies just to contributions made for that tax year.

IRA Recharacterization Rules

The IRS sets the rules for IRA recharacterizations and it’s important to know how they work.

First, you should know that if you’re recharacterizing contributions, any earnings on those contributions must also be recharacterized. Next, you’ll need to have a separate IRA to recharacterize contributions. Your current IRA custodian can help you set that up if you only have one retirement account.

You’re required to report recharacterizations on your federal tax return. Your IRA custodian should generate a Form 1099-R to help streamline the reporting process. Again, the deadline for changing your mind about IRA contributions is your regular tax filing deadline, either in April or October if you filed for an extension.

There’s no limit on how much of your contributions you can recharacterize and it can be a full or partial amount. However, Roth IRA conversion amounts cannot be recharacterized. The Tax Cuts and Jobs Act of 2017 also prohibits the recharacterization of amounts rolled over to a Roth IRA from another retirement plan, such as a 401(k) or 403(b).

How to Recharacterize an IRA

If you’re interested in recharacterizing traditional IRA contributions to Roth contributions or Roth to traditional, the easiest way to get started is by contacting the company that holds your account. Your IRA custodian should be able to help you through the process of completing a recharacterization.

You’ll need to tell your custodian:

What type of recharacterization do you want to make
How much of your contributions recharacterize

Your custodian should be able to calculate the earnings on your contributions that also need to be recharacterized and provide the necessary tax forms for reporting it to the IRS.

If you’re not sure whether an IRA recharacterization is the right move, you may want to talk to a financial advisor before starting the process. An advisor can evaluate your tax situation and help you figure out which type of IRA is best for your situation and whether recharacterizing contributions makes sense.

IRA Recharacterization Example

Having an example to reference can make it easier to understand how recharacterization works. Let’s say that you decide to open a Roth IRA and make a $6,000 contribution for the 2023 tax year. You make the full contribution in January, only to realize at the end of the year, you’ve made too much money to qualify for a Roth IRA.

You decide to recharacterize that contribution, along with $400 in earnings, to a traditional IRA. You’re not covered by a retirement plan at work so you can also deduct your full traditional IRA contribution for the year.

IRA Recharacterization vs. IRA Conversion

A recharacterization allows you to change your IRA contribution type in a single tax year. If you’d like to move from one type of IRA to another permanently, then you might carry out an IRA conversion instead.

For example, you might consider converting a traditional IRA to a Roth account. Roth IRA conversions can appeal to investors who may be ineligible to contribute to a Roth account, based on their income. You may also consider switching to a Roth IRA if you’d like to be able to withdraw your savings tax-free in retirement.

There is a catch, of course. When you convert traditional IRA assets to a Roth IRA, the IRS doesn’t just give you a pass on taxes. You’ll still have to pay taxes on the earnings from your traditional IRA contributions at the time of the conversion. Once you’ve gotten that out of the way, however, you’d be able to take qualified distributions from your Roth account tax-free.

The Bottom Line

IRA recharacterization can allow you to fix mistakes with retirement plan contributions or change your mind about the type of contributions you make for the tax year. If you think you might need to recharacterize IRA contributions, then it’s better to start planning for that sooner rather than later. Otherwise, you might end up missing the deadline for doing so.

Retirement Planning Tips

Converting IRA assets can yield some useful tax benefits, however, it’s important to understand how it can affect your tax liability in the near-term, especially if you’re converting a significant amount of money that could leave you with a sizable tax bill to pay. Talking to a financial advisor about the pros and cons can make it easier to decide if an IRA conversion might be right for you. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re not using an IRA to save for retirement yet, you may want to consider the benefits of opening one. As mentioned, traditional IRAs can allow for tax-deductible contributions while a Roth IRA can offer tax-free withdrawals in retirement.