Good Financial Reads: The ABCs of IRAs: Conversion, Recharacterization, and Taxation

Retirement planning can sometimes feel like a game of chess. You think two or three moves ahead, but then life makes an unexpected move of its own. For medical professionals in Chicago - from nurse practitioners at Advocate Lutheran General, to anesthesiologists at Rush Medical Center, to dentists managing suburban practices - those surprises often come in the form of fluctuating income, tax law changes, or career shifts.

One retirement planning tool that doesn’t get nearly enough attention is the Roth IRA recharacterization. It’s a mouthful, but the concept is simple: it allows you to change the type of IRA contribution you’ve made, after the fact. For high earners in medicine, where tax brackets, bonuses, and side income can shift quickly, understanding this option is more than just trivia - it can be a real money-saver.

But here’s the twist: the rules changed a few years ago. Some strategies that used to work - like undoing a Roth conversion - are now off the table. That makes it critical to understand what recharacterization still allows, what it doesn’t, and when it makes sense to use it.

 

Understanding Taxation of Withdrawals from Roth IRAs - The Two 5-Year Rules for Roth IRAs (With Real-World Scenarios)

by Zack Gutches, CFP®, CPA, True Riches Financial Planning

Roth IRAs are one of the most powerful tools for tax-free growth and eventual tax-free cash-flow (whether in retirement or before) —but only if you understand the rules. Two key “5-year rules” determine whether your Roth IRA withdrawals will be taxed or penalized. Confusion around these rules can lead to unpleasant surprises, especially for early retirees, high-income earners, or anyone converting traditional IRA money to a Roth IRA.

In this guide, we’ll explain the two 5-year rules, walk through the IRS’s ordering rules for Roth IRA withdrawals, and answer common questions with real-life examples.

Before diving into recharacterization, let’s revisit the playing field.

Traditional IRA: Contributions may be tax-deductible (depending on income and whether you have a workplace plan). Growth is tax-deferred. Withdrawals in retirement are taxed as ordinary income.

Roth IRA: Contributions are after-tax. Growth is tax-free. Withdrawals in retirement are tax-free if the rules are followed.