Help - Recharacterize excess contribution to traditional IRA

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Help - Recharacterize excess contribution to traditional IRA

Postby spocksynder » Sun Feb 10, 2013 8:13 pm

Hello,
This is the first year I started making contributions to a traditional IRA. On Jan. 15, 2013, I made a $5000 contribution to traditional IRA, assuming that my MAGI would be under the income limits. But when I completed my taxes in TaxAct, I realized that I was only eligible to make $2850 in contributions to traditional IRA that could be made deductible(I participate in a retirement program). I now have an excess contribution of $2150 to the traditional IRA.

TaxAct tells me that I don't owe penalty for the excess contribution since it is under the limit. I don't want to make a non-deductible IRA contribution at this time. I'd rather have it changed to a RothIRA. What are my options in this scenario:

I don't care about the deductible part of the traditional IRA too - so, can I convert the entire $5000 contribution to a Roth IRA? Or, am I limited to characterizing only the excess contribution over the limit as RothIRA contribution? Or, I don't have any options, and cannot change anything with the contribution?
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Re: Help - Recharacterize excess contribution to traditional

Postby kaneohe » Sun Feb 10, 2013 8:50 pm

Contact the broker or financial institution and have them recharacterize the whole contribution.
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Re: Help - Recharacterize excess contribution to traditional

Postby spocksynder » Sun Feb 10, 2013 9:18 pm

kaneohe wrote:Contact the broker or financial institution and have them recharacterize the whole contribution.

Thank you for the reply.

There's been a little gain in the time since the contribution to the traditional IRA - will that be a problem?
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Re: Help - Recharacterize excess contribution to traditional

Postby kaneohe » Sun Feb 10, 2013 9:35 pm

No......what I remember about recharacterization of a contribution is that it's like you never made the first assignment in the first place....
i.e. it's like you made a Roth contribution to begin with so they should take the whole current value.
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Re: Help - Recharacterize excess contribution to traditional

Postby kaneohe » Sun Feb 10, 2013 10:33 pm

You might want to read the recharacterization section of this: http://www.irs.gov/instructions/i8606/ch01.html#d0e470
I think example 2 reflects your situation. They have some instructions about reporting the recharacterization as a simple narrative describing the
original contribution (type, amount, date) and then the recharacterization (same type of info).
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Re: Help - Recharacterize excess contribution to traditional

Postby Alan S. » Sun Feb 10, 2013 10:55 pm

While you indicated you wanted to recharacterize the entire contribution, you certainly do not have to. You could recharacterize only the 2,150 that you cannot deduct. You would end up with a 2,850 deduction and a 2,150 regular Roth IRA contribution. Of course, the better the gains on your contribution, the more likely you might be to recharacterize the entire contribution as that would result in all the gains going into the Roth IRA instead of just 43% of them. However, you are entitled to the partial deduction if you want to only partially recharacterize, and that will lower your tax bill.

What you should really avoid here is a corrective distribution of the non deductible portion as the earnings will increase your MAGI and further reduce your deduction in a vicious circle. For that reason full or partial recharacterization is best, and a partial recharacterization is the same amount of work as a full recharacterization. Your tax return should include the explanatory statement regarding your contribution and recharacterization, since the IRS will not know what you did till Jan, 2014 otherwise and could contact you.

NOTE: You don't have an excess contribution here because a non deductible portion of your contribution is allowed. However, if you do not enter the recharacterization into the tax program you will end up with a deduction for 2,850 and a Form 8606 reporting a non deductible contribution of 2,150. You should avoid that by recharacterizing either 43% of the contribution or the entire contribution.
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Re: Help - Recharacterize excess contribution to traditional

Postby spocksynder » Sun Feb 10, 2013 11:32 pm

Alan S. wrote:What you should really avoid here is a corrective distribution of the non deductible portion as the earnings will increase your MAGI and further reduce your deduction in a vicious circle. For that reason full or partial recharacterization is best, and a partial recharacterization is the same amount of work as a full recharacterization. Your tax return should include the explanatory statement regarding your contribution and recharacterization, since the IRS will not know what you did till Jan, 2014 otherwise and could contact you.

Thank you for this really important note - I had completely missed the part about it increasing my MAGI again. I think I will recharacterize the non-deductible 2150 portion of the contribution as Roth IRA.

Again, thank you all for the replies, and your guidance. This forum has been a great help for novices like me.
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