Practical analysis for investment professionals
30 January 2014

Demystifying the IRA Recharacterization Option (Podcast)

Navigating tax strategies can be particularly tricky to begin with, and the flurry of advice following the IRS’s relaxation of Roth IRA recharacterization rules (which removed the restrictions on higher-income individuals converting their IRAs) caused no small amount of confusion in the financial community. John D. Stowe, CFA, and his coauthors, David L. Stowe, CFA, and Andy Fodor, use option-pricing models to estimate the value of the recharacterization option and provide data for investors to consult when they’re trying to understand the option and choose a strategy. Their research was published in the September/October 2013 issue of the Financial Analysts Journal in an article titled “The Value and Use of the IRA Recharacterization Option.” Stowe shared some of his thoughts on his work in the latest installment of our ongoing FAJ author interview series.

Stowe explains in the interview that the conversion option is “a lot more valuable” than most investors think. “We tried to use option-pricing models and simulation models to demonstrate what the value of this recharacterization process is,” he says, “and it looks like it’s in the ballpark of 5–20% of the ultimate value of a portfolio.”

That figure becomes even more impressive when combined with the amount of money involved: “There’s about $5 trillion of traditional IRAs in the United States and another $5 trillion of 401(k)s that could probably go through this recharacterization process,” says Stowe. “This choice of tax treatment after the fact — after you’ve learned that your portfolio went up or down — is extremely interesting. It’s a valuable option.”

To hear Stowe’s thoughts on the recharacterization option and the types of investors who need to pay attention to it, listen to the full interview above or download the MP3.

CFA Institute members can access the full article on the CFA Publications website.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Pat Light

Pat Light was an assistant editor at CFA Institute. Before joining the CFA Institute editorial staff, he worked as a teacher. Light has a bachelor's degree in English from Duke University.

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