Recharacterization Mechanics

Steps involved in undoing a Roth IRA transaction.

If you've read the preceding pages in this subtopic, you already know about recharacterization in general. You also know the recharacterization rules, such as whether you're eligible and within the time limit. In that case you're ready to learn how to do it.

Set Up a New IRA

Recharacterization involves switching your contribution from one IRA to another, so the first thing you need to do is set up a new IRA.* The new IRA can be with the same financial institution that maintains the IRA that received your contribution, or it can be with a new IRA provider. The important thing is that the transfer is directly from one IRA to another. You're not allowed to take the money out and put it in a new IRA within 60 days, as you can with a regular rollover.

* You don't have to set up a new IRA if you want the money to go to another IRA that already exists. For example, you might already have a traditional IRA, then set up a Roth IRA with a $3,000 annual (non-rollover) contribution. If you decide you should have made that contribution to the traditional IRA instead, you can use that old IRA as your "new" IRA.

Notify the IRA Providers

The regulations say you have to notify the financial institution maintaining both the old IRA and the new one that your transfer is intended as a recharacterization. Merely transferring funds without this notice won't qualify as a recharacterization. If you're transferring to a new trustee as well as a new IRA, you must provide the notice to both trustees. If you're transferring to a new IRA with the same trustee, you'll only have to provide one notice. The notice must be provided on or before the date of the transfer.
    The IRS doesn't have a form for the notice. Your IRA provider should tell you what paperwork is involved. It should include all of the following:

• An appropriate heading, such as: "Notice to IRA Trustee of Election to Recharacterize Contribution".
• Your name, address and social security number. (The Roth IRA regulations don't mention this, but it's pretty obvious that you want these to be on the notice.)
• The type and amount of the contribution to the first IRA that is to be recharacterized.
• The date on which the original contribution was made to the first IRA.
• The year for which the original contribution was made. (A contribution made in the early part of one year can be made for the previous year.)
• A direction to the trustee of the first IRA to transfer to the trustee of the second IRA to transfer, in a trustee-to-trustee transfer, the amount of the contribution and net income allocable to the contribution to the trustee of the second IRA. (If you're switching IRAs without changing trustees, this would be a direction to transfer the relevant amount from the first IRA to the second IRA.)
• The name of the trustee of the first IRA and the trustee of the second IRA.
• Any additional information needed to make the transfer (for example, account numbers, telephone numbers, addresses).

Once you've made up this notice, you can send it to both trustees with a brief cover letter. The letter to the first trustee will say, "Please make the transfer indicated in the enclosed notice," and the letter to the second trustee will say, "Please process the transfer to my account from [name of first trustee] in accordance with the enclosed notice." If there's only one trustee involved, the second letter and notice aren't needed. Keep a copy of the notice with your permanent tax records.

Follow-Up

After you send the notice, you should follow up with the IRA provider(s) to make certain the transfer was made in accordance with your instructions prior to the deadline. Mistakes happen! When you file your income tax return for that year, check the Form 8606 instructions to determine what reporting obligations you have.

Transfer Before Recharacterization

What if you transferred money from one IRA to another before making the recharacterization switch? For example:

• You converted a traditional IRA (IRA1) to a Roth IRA (IRA2).
• Then you rolled that Roth IRA (IRA2) to a different Roth IRA (IRA3) maintained by a different provider.
• Now you want to undo the original conversion with a transfer to a newly formed traditional IRA (IRA4).

That could be an awkward situation, because you're trying to recharacterize a rollover contribution to an IRA that no longer exists. Fortunately the folks at Treasury foresaw this possibility when they wrote the regulations. These rules say you should disregard any tax-free transfers that occur between the date of the original contribution or conversion and the date you make the reconversion transfer, provided that you transferred any earnings along with the contribution. The regulations indicate that the notice described above would go to the providers of IRA3 and IRA4.*

* The regulations aren't completely clear on this point, so if you want to be completely safe you can send the notice to the provider of IRA2 as well.

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