Federal Employees News Digest

Employees Have Until Tax Filing Deadline to “Recharacterize” 2018 IRA Contributions

Many federal employees and if married, their spouses, have made their 2018 individual retirement arrangement (IRA) contributions. Previous columns discussed the two types of IRAs available – traditional and Roth - and these columns further discussed the rules and requirements for making traditional and Roth IRA contributions. This column discusses what an individual can do if he or she discovers that a contribution was made to the wrong type of IRA.

Recharacterization

Contributions to one type of IRA can be treated as having been to a different type of IRA. For example, contributions to a Roth IRA can be made as treated as contributions to a traditional IRA. This is called recharacterizing the contribution.

Why would an individual want to recharacterize an IRA contribution? Once possibility would be the example of an individual who during 2018 made a Roth IRA contribution and now, early in 2019, has discovered his or her 2018 modified adjusted gross income (MAGI) was over the allowable limit for making a 2018 Roth IRA contribution. A previous “Informed Investor” column discussed the MAGI limits for making Roth IRA contributions. The individual exceeded the MAGI limits and can now recharacterize the contribution as a nondeductible traditional IRA contribution. If the recharacterization is performed in the proper way and before the individual files his or her 2018 federal income tax return, there will be no tax consequences and no penalties.

Here is an example that illustrates the recharacterization process:

Judy is a federal employee covered by FERS, and contributes to the Thrift Savings Plan (TSP). She contributed $5,000 to a new deductible traditional IRA on Sept. 26, 2018. On Feb. 19, 2019, Judy’s traditional IRA is worth $5,500. She decides to recharacterize $4,000 of the traditional IRA contribution as a Roth IRA contribution. To accomplish this, Judy has $4,400 ($4,000 contribution plus $400 related earnings) transferred from her traditional IRA to a Roth IRA in a trustee-to-trustee transfer. Judy deducts the $1,000 traditional IRA contribution on her 2018 Form 1040. She is not required to file IRS Form 8606, but she must attach a statement to her 2018 federal tax return that indicates the following:

1. She contributed $5,000 to a traditional IRA on Sept. 26, 2018;

2. She recharacterized $4,000 of that contribution on Feb. 19, 2019 by transferring $4,000 plus $400 of related earnings from her traditional IRA to a Roth IRA in a trustee-to-trustee transfer.

3. The entire $1,000 of the remaining IRA contribution is deducted on Form 1040.

Judy does not report the $4,400 distribution from her traditional IRA on her 2018 Form 1040 because the distribution occurred in 2019. She does not report the distribution on her 2019 Form 1040 because the recharacterization was related to 2018 and was explained in an attachment to her 2018 tax return.

The following table summarizes the reporting of a recharacterization of an IRA contribution:

Reporting a Recharacterization

Initial Contribution

Recharacterization

Report on IRS Form 8606

Recharacterization and Contribution in the Same Year

 

Contribution to a traditional IRA

 

Transfer to a Roth IRA

Only the part, if any, of the contribution that is not recharacterized (the amount left in the traditional IRA, to the extent it is nondeductible.

 

Amount transferred from the traditional IRA to the Roth IRA

 

Contribution to a Roth IRA

 

Transfer to a traditional IRA

Only the part, if any, of the contribution that is recharacterized to the traditional IRA, to the extent it is deductible

 

Amount transferred from the Roth IRA to the traditional IRA

Finally, effective Jan. 1, 2018, under the Tax Cuts and Jobs Act of 2017 (TCJA), conversion from a traditional IRA, a SEP IRA, or a SIMPLE IRA to a Roth IRA cannot be recharacterized. TCJA also prohibits recharacterizing amounts rolled over to a Roth IRA from other retirement plans, such as the traditional TSP, 401(k) or 403 (b) retirement plans. Therefore, with the passage of TCJA, recharacterization cannot be used to unwind a Roth IRA conversion. But TCJA permits recharacterization of traditional and Roth IRA contributions, as discussed above.

Edward A. Zurndorfer is a Certified Financial Planner, Chartered Life Underwriter, Chartered Financial Consultant and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, located at 833 Bromley Street Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652.

Reader comments

Please post your comments here. Comments are moderated, so they may not appear immediately after submitting. We will not post comments that we consider abusive or off-topic.

Please type the letters/numbers you see above

Contributors

Edward A. Zurndorfer Certified Financial Planner
Mike Causey Columnist
Tom Fox VP for Leadership and Innovation, Partnership for Public Service
Mathew B. Tully Legal Analyst

Free E-Newsletter

FederalDAILY

I agree to this site's Privacy Policy.

Stay Connected

Latest Forum Posts

Ask the Expert

Have a question regarding your federal employee benefits or retirement?

Submit a question