Retirement Savings Strategy Thwarted by New Tax Law

Posted on Thu, Mar 15, 2018 ©2021 Drucker & Scaccetti

KarolynBy: Karolyn R. Banks, CPA, MT


Another casualty of the 2017 Tax Cuts and Jobs Act (“TJCA”) is the ability to recharacterize a Roth IRA conversion. Prior to this change, taxpayers generally had until October 15 of the year following the year of a Roth IRA conversion to recharacterize the transaction. With the president’s signing of the TJCA, those saving with Roth IRAs must rethink this strategy.


Background on Roth IRAs

The Roth IRA was established in 1997 under the Taxpayer Relief Act is a a popular retirement savings tool. Contributions to a traditional IRA are usually deductible with the funds growing tax deferred and only taxed when distributions are made. A Roth IRA differs because contributions are not deductible when made and the funds grow tax free with  distributions not taxable when distributed for retirement.


However, there is a catch!, Contributions to a Roth IRA is only available to individuals with adjusted gross income (“AGI”) below a specific amount. In 2018, married taxpayers with AGI below $189,000 ($120,000 for single taxpayers) are generally eligible to contribute up to $5,500 ($6,500 for individuals age 50 and above) to a Roth IRA. Individuals with AGI above these amounts can still contribute to a Roth IRA but the allowable contribution is limited and is completely phased out for married taxpayers with AGI of $199,000 or higher ($135,000 for single taxpayers).


Changes in 2010

Before 2010, individuals with modified AGI above $100,000 were not eligible to convert qualified retirement accounts to Roth IRAs. In 2010 the income cap for Roth IRA conversions was eliminated, and many taxpayers made contributions to non-deductible traditional IRA accounts they later converted to Roth IRAs—often called “backdoor” Roth IRAs. Many also converted larger traditional IRA accounts and other qualified retirement accounts to Roth IRAs when the economics made sense.


For those making these conversions, a safety net was available. If the account lost significant value between the time of the conversion and the extended due date of the tax return, you could simply recharacterize a Roth IRA conversion. Why does this matter? When you make a Roth IRA conversion, you must include the value of that conversion as of the date of the conversion in your taxable income. If value of the account drops significantly, you may pick up more income than you could recoup from tax-free growth after the conversion. Basically, there was an “undo” button available for when conversions didn’t work out economically, which resulted in reduced tax liabilities for those converting.


Changes Under TJCA

Under the TJCA, the ability to recharacterize a Roth IRA conversion was eliminated. Beginning in 2018, recharacterizations are not allowed for amounts converted in 2018 to a Roth IRA from a traditional IRA or other qualified retirement account. Fear not if you made a conversion in 2017; that transaction can still be  ‘recharacterize!’ The IRS updated its Frequently Asked Questions to indicate taxpayers still have until October 15, 2018, to recharacterize 2017 conversions.


Because of the TJCA, taxpayers are warier to convert to a Roth IRA since they no longer have the option to recharacterize should the account value drop significantly shortly after conversion.  There are many factors to consider when deciding whether to convert a qualified retirement account to a Roth IRA. The Tax Warriors® are always prepared to help you weigh the numerous factors and tax implications of possible Roth IRA conversions. Contact us today to schedule a consultation.

Topics: Roth IRA, Tax Cuts and Jobs Act, Trump Tax Reform, Recharacterization

Read & Submit A Comment