Roth Recharaterizations are no longer part of the tax code.
For a description of how this changes this Roth conversion strategy, read “No Roth Recharacterizations After 2017?”
Roth conversions and Required Minimum Distributions (RMDs) can be scary to combine if you don’t understand the rules. That being said, with a thorough understanding of the IRS rules, performing a Roth Conversion even after your so-called Required Beginning Date (RBD) can be a breeze.
Before reading this article, make sure you understand how Required Minimum Distributions work by reading our article “Understanding Your IRA Required Minimum Distributions (RMDs)” and the timing requirements for RMDs in years you are doing Roth conversions by reading our article “Roth Conversion: Take Your Required Minimum Distribution Out First.”
A Roth conversion is the process of moving assets from a traditional IRA (tax-deferred) to a Roth IRA (after-tax). Unlike many monetary transfers, you are allowed to undo a Roth conversion any time before you file your tax return by using a Roth recharacterization. A recharacterization is a true undo; the recharacterized assets incur no tax.
You are allowed to recharacterize converted assets any time before you file. This means, that even if you converted the assets in 2016 (a 2016 tax-year taxable event), you can recharacterize them any time before October 15, 2017, the late filing deadline.
As a true undo, however, this 2017 recharacterization affects your Required Minimum Distribution.
Imagine you converted 50% of your IRA value in 2016 using a Roth segregation strategy. You have the assets segregated, 10% in five separate Roth conversion IRAs, and are watching for which one will be the winner.
In January 2017, you have to calculate your new RMD. You do this, first, by looking up the value of your IRA at the end of the year as of December 31, 2016. Keep in mind that 50% of your IRA is currently not in your IRA but rather in Roth conversion accounts participating in the Roth segregation strategy. This makes your RMD half of what it would have been had you not converted.
This is okay for now, but in early October 2017, you select your Roth segregation winner and put back the remaining four conversions back in your Traditional using a Roth recharacterization.
A Roth recharacterization is a true undo; it is as though you never converted those assets in the eyes of the IRS. This includes recalculating your RMD had you not converted the assets.
Had you not converted, those assets would have been a part of your end of year value on December 31, 2016 and would have made your RMD that much bigger. Thus, recharacterizing them increases the amount of your 2017 Required Minimum Distribution.
Although you would assume that you have to go and look back at the value of these assets on December 31 and add that back in to your RMD caluclation, the process is actually simpler than that. No one is required to report to the IRS your Roth conversion IRAs December 31 value, thus they would have no way of fact-checking whether you have done your RMD calculation correctly.
Your custodian is, however, required to report contributions to retirement accounts and distributions from retirement accounts.
Thus, the IRS uses the value of your recharacterized assets at recharacterization, meaning the amount that is contributed back to your Traditional IRA, to adjust your RMD.
So let’s say your Roth segregation strategy was to convert $10,000 into each of five separate Roth conversion IRAs. Then, by October 2017, the five accounts were worth $15,000; $12,000; $10,000; $9,000; and $6,000. You keep the winner – the one worth $15,000 – and put the others back in your Traditional IRA via a recharacterization.
Your end of year value for the purposes of your RMD would be $37,000 higher, the sum of your recharacterized accounts values at recharacterization ($12,000 + $10,000 + $9,000 + $6,000). Note that this valuation may be higher or lower than the original basis characterized or the actual value of the segregated accounts at the end of the year. Using this new adjustment, you would compute your new RMD requirement for the year.
To calculate your new recharacterization-adjusted RMD, you would take the actual end of year value and add in the sum of your recharacterized accounts values at the time of their recharacterization ($37,000 in this example). That recharacterization-adjusted sum would then be divided as it normally is by your life expectancy factor according to the table.
If you are fulfilling your RMD monthly, this will likely require an increase to your remaining monthly withdrawals.