What's the difference between a conversion and a recharacterization?

Modified on Thu, 02 Feb 2023 at 07:44 PM

If you want to move your traditional IRA funds into a ROTH IRA, this movement typically comes with tax implications. This type of transaction is often referred to as a conversion. A recharacterization, however, lets you change your mind about how your IRA funds are labeled, removing your tax implications.

Why would you make a conversion or recharacterization transaction in the first place? Well, you may decide you want to convert your traditional IRA funds to a ROTH IRA, since a ROTH IRA does not have taxes withheld when you withdraw your funds. But, since you contribute to a traditional IRA with pre-tax dollars, moving money across accounts is not like comparing apples to apples.

Instead, your money move would be classified as a conversion, which would impact your taxes, and may leave you with a tax bill. There’s no transaction limit when making a conversion.

However, you have until April 15 (or October 15 if you get an extension) to decide if you want to recharacterize a previous year’s contribution. For instance, if you contributed $5,000 to your traditional IRA and decided you’d rather contribute this to your ROTH IRA, you could recategorize the contribution without a tax penalty.

You can only recategorize contributions for the previous year (up until you file your taxes) or the current year. And, you can only recategorize up to the contribution limit for the year (for 2022, this is $6,000).

Both conversions and recharacterization transactions will be reported on your IRA tax forms.

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