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Here is a subject of relevance for retirement investors -- given the decline in the stock market since May -- recharacterizing your Roth IRA conversion.
Recharacterization is the process of unwinding your previous conversion as if it never happened. Let's say earlier this year you converted traditional IRA assets to a Roth, triggering a tax bill based on the amount converted (less any nondeductible contributions that had been made). If you now have any regrets, recharacterizing is the equivalent of hitting the rewind button, undoing the conversion and going back to a traditional IRA.
Why recharacterize? You may wish to do so because of a drop in the account value since conversion, unwinding the tax obligation based on say, a $20,000 conversion that is now only worth $15,000. You may regret the conversion for other reasons, such as having pushed your adjustable gross income above the eligibility thresholds for certain tax credit or financial aid, or because you don't have -- or don't want to part with -- the cash to cover the taxes. This last point is alleviated somewhat by the option that exists only in 2010, to spread the resulting tax bill over tax years 2011 and 2012 instead of paying it entirely in 2010.
You can hear a more detailed discussion by listening to a recent radio appearance of mine on "Market Wrap with Moe Ansari," hosted by Moe Ansari, President and Chief Portfolio Manager at Compak Asset Management. Also, check out this Bankrate article on recharacterizing an IRA conversion.
Barbara,
Did you have taxes withheld when you converted? My guess is that the custodian is telling you that you need to send in the money that went to the IRS/state.
BTW - You should not have withheld on the conversion since it is taxable and possibly penalized.
If the account value has dropped, you only recharacterize the current value. I don't know of any instance where you'd need to "make up the difference" from your Roth IRA. Not sure who told you that but double-check that info...it doesn't seem right.
Recharacterizing erases the previous tax bill generated by the conversion. But the loss is not deductible. In tax-advantaged accounts, you don't pay taxes on gains or have the ability to deduct losses. Uncle Sam gets his money when you withdraw from a Traditional IRA or when converting a Traditional IRA to a Roth IRA.
I am planning to recharacterize my Roth Convertion back to traditional IRA. It's decreased in value, and I'm told I need to make up the difference from my Roth IRA. How is this loss handled for taxes.