Retirement Spotlight: How Tax Reform Changed IRA Recharacterizations

The recent tax reform bill made a few changes to IRAs and retirement plans. You may have heard rumblings about one of them involving IRA recharacterizations. The change, which took effect January 1, 2018, reduces the scenarios in which IRA owners may choose to recharacterize a contribution. To help you understand and prepare for this change, let’s take a closer look at both the old and new recharacterization rules.

Old Recharacterization Rules

The recharacterization rules generally allowed you to “undo” certain transactions. You could recharacterize a contribution for any reason as long as it was completed by your tax return due date, plus extensions.

Before January 1, 2018, you could recharacterize a

  1. regular Traditional IRA contribution to a Roth IRA,
  2. regular Roth IRA contribution to a Traditional IRA,
  3. conversion of Traditional or SIMPLE IRA assets back to the original type of IRA, and
  4. retirement plan-to-Roth IRA rollover to a Traditional IRA.

New Recharacterization Rules

Under the new rules, your list of recharacterization options has been trimmed from four to two.

As of January 1, 2018, scenarios 3 and 4 (shown above) do not apply. You may no longer recharacterize a Roth IRA conversion, from any source. It is now a one-way transaction without an “undo” feature.

Options 1 and 2 remain unchanged. You can continue to recharacterize a regular current year IRA contribution by your tax return due date, plus extensions.

The new rules are clear about conversions and retirement plan-to-Roth IRA rollovers that occur in 2018—they cannot be recharacterized. But whether conversions and retirement plan rollovers completed in 2017 can be recharacterized in 2018 is unanswered in the new rules. Ascensus contacted an IRS representative who said that IRS was aware of this issue and that conversions and retirement plan rollovers completed in 2017 may be recharacterized in 2018.

Going Forward

If you are considering a conversion or retirement plan-to-Roth IRA rollover, you’ll want to carefully consider the new recharacterization restrictions. If you completed a conversion or retirement plan-to-Roth IRA rollover in 2017 and wish to recharacterize it in 2018, note that the IRS’ comments were provided in an unofficial, verbal conversation. As a result, you should consider talking to your tax or financial professional beforehand.