Life and Death Planning for Retirement Benefits

Chapter 5: Roth Retirement Plans

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 For a corrective distribution, distributing the entire account balance to the participant will satisfy the requirement of returning the contribution and net income attributable thereto. § 1.408-11(a)(2) .  If the entire contribution is being recharacterized, transferring the entire account balance to the other type of IRA satisfies the requirement. Reg. § 1.408A-5 , A-2(b); see Fouad Example below. Because Method 1 is much simpler to apply than Method 2 (below), there is an advantage to keeping each year’s Roth IRA conversion contributions in a separate Roth IRA account (not commingled with any pre-existing Roth IRA), until the deadline for recharacterizing such contributions ( ¶ 5.6.02 ) has passed. Method 2: If Method 1 is not available, then the net income attributable to the contribution must be calculated using the following formula (Reg. § 1.408-11(a)(1) ): See the regulation for details on this formula, and see Reg. § 1.408A-5 , A-2, for examples of applying the formula to Roth recharacterizations. For purposes of applying this formula, IRAs are not aggregated; earnings are computed only with respect to the actual account to which the contribution was made, even if the individual owns multiple IRAs. Reg. § 1.408-11(a)(2) , § 1.408A-5 , A-2(c)(4). Compare ¶ 5.2.03 (B). Fouad Example: Fouad converted $200,000 from his 401(k) plan to a new separate Roth IRA account in January 2010. This Roth IRA contained no other contributions, received no other contributions, and made no distributions. By November 2010, the account had declined in value to $160,000, and he decided to recharacterize. He closed the Roth IRA and transferred its entire value ($160,000) to a traditional IRA. He has successfully recharacterized his entire conversion, because he transferred to the traditional IRA the $200,000 contribution plus the “earnings thereon”; the “earnings” were a loss of $40,000. He can then “reconvert” this IRA to a Roth in 2011 (see ¶ 5.6.07 ). A recharacterization is effected by transferring the contribution that is to be recharacterized (plus earnings attributable thereto) to the other type of IRA by a certain deadline. § 408A(d)(7) . A recharacterized contribution will be treated for income tax purposes as having been contributed to the transferee IRA (rather than the transferor IRA) “on the same date and (in the case of a regular contribution) for the same taxable year that the contribution was made to the” transferor IRA. Reg. § 1.408A-5 , A-3. Although the Code makes it appear that any transfer of the IRA contribution amount to the other type of IRA before the applicable deadline is automatically treated as a recharacterization, the Regulation is clear that the treatment is elective. Reg. § 1.408A 5, A 1(a), (b), A 6. For which contributions may NOT be recharacterized, see ¶ 5.6.01 . For partial recharacterizations, see ¶ 5.6.04 . For the deadline applicable to recharacterizations, see ¶ 5.6.02 . How to recharacterize certain IRA/Roth IRA contributions Net Income equals: Contribution x (Adjusted Closing Balance-Adjusted Opening Balance) Adjusted Opening Balance