How to revert Roth IRA contribution when income eligibility exceeded

[kambyvk]

I made Roth IRA contributions in 2018 and 2019 and in hindsight my income in both years exceeded the MAGI levels stipulated to be eligible for contribution. The contribution amount ($6500+$7000=$13500) is the only amount sitting anywhere in a Roth IRA account for me, in this case at Fidelity. What I have read on this forum and elsewhere on similar situations is to either recharacterize to a traditional IRA or move the contribution to the following year, if the income is expected to fall below the MAGI threshold. My income level exceeds limits for traditional IRA contributions for both FY 2018 and 2019 so recharacterization is out and although I will fall below the MAGI threshold next year, I will have no earned income (retired, with all settlements from my former employer paid out this year) so I don’t think I can contribute to either type of IRA.

In this situation is my only recourse to pay the penalty (I understand it is 6% per year) and have the remaining amount deposited in my taxable cash account, which is where the contributions were sourced from to start with? Further, is the penalty applicable on the full contribution amount or only to any earnings on the contribution since the time of contribution?

Many thanks in advance for your help.

[ivk5]

There is no income limit for tIRA contribution, only for deducting the contribution from income. You can recharacterize to (non-deductible) tIRA for 2019.

If you have no other tIRA accounts in your name, note that you can subsequently convert the recharacterized amount from traditional to Roth. (Lookup Backdoor Roth in wiki.) If you have other tIRA funds, that will be undesirable.

For 2018 the recharacterization deadline has passed (Oct 15, 2019 for most taxpayers). So I think you’ll have to pay the excise tax and withdraw. Why wasn’t this flagged by your 2018 tax software/preparer? That should have been routine.

All caps title not necessary (no need to shout).

[kambyvk]

First of all, apologies. The intention was not to shout, copied the contents from a Word document where I typed the post and the header was in caps, should have been bit more aware of how this may come across.

Thanks for your response. I could recharacterize the 2019 contribution to a tIRA but subsequent backdoor Roth will not be straightforward as I do have another Rollover tIRA already. For 2018, good to know that paying the penalty and withdrawing is the only option. I can get going on this. Much appreciated.

[kambyvk]

Just completed recharacterizing 2019 to tIRA and did a "return of excess" for 2018 (6% penalty). Fidelity rep took me thru the process for both and it was quite easy. Thanks again!

[lakpr]

Just completed recharacterizing 2019 to tIRA and did a "return of excess" for 2018 (6% penalty). Fidelity rep took me thru the process for both and it was quite easy. Thanks again!

Uh oh

Since you said you have a Rollover IRA, and now you have this non-deductible traditional IRA ... any withdrawal from either IRA in the future will be treated as a proportional withdrawal from non-deductible IRA (non-taxable) and Rollover IRA (taxable). You are now forever wedded to Form 8606 throughout your life for any withdrawals made from either the Rollover IRA or the traditional IRA. For what it is worth, I hope you keep them separate and do NOT mix them together.

I see that you are retired, and presumably not looking to work again and are looking to live off the Rollover IRA. If you can get at least a part time job with a 401k long enough to roll the Rollover IRA into it ... then you can convert the non-deductible IRA to Roth IRA again and then retire again for good (and do NOT roll the 401k into a Rollover IRA again the same calendar year you did the Roth conversion).

[kambyvk]

Thanks lakpr, apologies for the late response I saw your post just now.

Indeed, I had not thought through the ramifications of the recharacterization fully and realized it after the fact. I did not expect the recharacterized funds to end up in the Rollover IRA. When I called Fidelity later, they said it went into the Rollover as that was the only Fidelity tIRA in my account (the only other one is a Janus one). One thing is that the recharacterized amount is a << small fraction of what was in the Rollover - I know this does not matter once the non-deductible and deductible are mixed.

When I asked if there was a way to fix this somehow, they said I could open another IRA account and move the recharacterized amount into that IRA so that I can then keep deductible and nondeductible contributions separately. They said Fidelity does not report IRA to IRA transfers. Is this a possible way out? Sounds too straightforward to be true. I have not done that as I want to fully understand implications before taking further steps.

On your other point, I do have a 401 account already at Fidelity from my 20+ years with my former employer. Fidelity did confirm that my former employer does allow moving the Rollover IRA into my 401K.

In hindsight I should have opened another tIRA account before the recharacterization and asked Fidelity to put the recharacterized amount in that IRA to keep everything clean.

[lakpr]

Thanks lakpr, apologies for the late response I saw your post just now.

Indeed, I had not thought through the ramifications of the recharacterization fully and realized it after the fact. I did not expect the recharacterized funds to end up in the Rollover IRA. When I called Fidelity later, they said it went into the Rollover as that was the only Fidelity tIRA in my account (the only other one is a Janus one). One thing is that the recharacterized amount is a << small fraction of what was in the Rollover - I know this does not matter once the non-deductible and deductible are mixed.

When I asked if there was a way to fix this somehow, they said I could open another IRA account and move the recharacterized amount into that IRA so that I can then keep deductible and nondeductible contributions separately. They said Fidelity does not report IRA to IRA transfers. Is this a possible way out? Sounds too straightforward to be true. I have not done that as I want to fully understand implications before taking further steps.

On your other point, I do have a 401 account already at Fidelity from my 20+ years with my former employer. Fidelity did confirm that my former employer does allow moving the Rollover IRA into my 401K.

In hindsight I should have opened another tIRA account before the recharacterization and asked Fidelity to put the recharacterized amount in that IRA to keep everything clean.

Does your former employer really allow the Rollover IRA to be rolled into the 401k plan, *even for former employees*? Double check this, because if true this is your golden ticket out of your predicament. Then the action items for you would be to, as Fidelity suggested, roll the recharacterized amount into a separate IRA, and then roll the Rollover IRA into your 401k plan. Then convert the recharacterized amount to Roth IRA.

That's at least a month for each of those three steps, you do have to be patient -- assuming that it's even possible.

Is your former employer GE by any chance? Because, outside of TSP, that's the only private plan I had heard that would allow former employees to roll their tIRA over into the 401k plan

[kambyvk]

I was put on a long hold while the Fidelity rep checked with Fidelity Shell (my former employer) reps and came back with the "good news" as he put it, and said it was possible to move the Rollover IRA into the 401K even though I am no longer with the company. That maybe because the funds in the Rollover IRA were sourced from my former employer (pension lumpsum).? To be sure, I will re-verify this once more to see if I get the same answer, before taking action.

I do have another deductible IRA (Janus), again a relatively small amount, but won't this have to be dealt with - I thought the "to be converted" tIRA had to be the only tIRA at the time of conversion to tIRA.

There is one other niggle in all of this and that is that I live overseas and I need to also factor in the tax consequences, if any, on the overseas tax return of these various moves. The Rollover IRA merge into 401K could trigger a tax consequence here and there is no concept of Roth IRA here.

[kambyvk]

Correction to my earlier post

I do have another deductible IRA (Janus), again a relatively small amount, but won't this have to be dealt with - I thought the "to be converted" tIRA had to be the only tIRA at the time of conversion to Roth IRA.

[retiredjg]

When I asked if there was a way to fix this somehow, they said I could open another IRA account and move the recharacterized amount into that IRA so that I can then keep deductible and nondeductible contributions separately. They said Fidelity does not report IRA to IRA transfers. Is this a possible way out? Sounds too straightforward to be true. I have not done that as I want to fully understand implications before taking further steps.

This does not change anything. To the IRS, it is still all one IRA. If you take money out, it will have to be pro-rated. Forever. This is only a little onerous, but some people want to avoid it.

If this last contribution is your only non-deductible contribution, you have four choices. If you have made other noon-deductible contributions, tell us.

1) Get a return of your 2019 contribution. You tell Fidelity you want to withdraw it as if you never made the contribution in the first place. Make this last part very clear so they don't just think you are making an ordinary withdrawal. You get your money out and the earnings as well - the earnings will be taxable for 2019.

2) If you don't want to go through pro-rating, just pretend you never made the non-deductible contribution. Don't document it on Form 8606. Just forget it. What will happen is that you will eventually pay tax on this contribution a second time as the IRA is emptied.

3) Leave it there and do the Form 8606 and pro-rate every time you take money out or do a Roth conversion. People don't like this but it is only one form and easy enough if you understand what you are doing.

4) Roll everything but your basis (the contribution) into the 401k. However, it is very unusual for a plan to accept a rollover from a separated employee. Double check it.

In hindsight I should have opened another tIRA account before the recharacterization and asked Fidelity to put the recharacterized amount in that IRA to keep everything clean.

Would not have helped at all.

[retiredjg]

Considering that you live overseas, I'd just go for option #1 - have your 2019 contribution withdrawn as if you never made it.

Or pretend it was not non-deductible and don't worry about it.

[Katietsu]

I agree with retiredjg. The benefit of all of this, if any at all, is too small for the hassle.

Just remove the 2019 contribution plus associated earnings. Make sure they know you are asking for a return of your 2019 contribution.
Edited to delete incorrect information.

[kambyvk]

Many thanks retiredjg for detailing the various options, much appreciated.

Yes, this ended up being the only non-deductible contribution (made in 2018, originally as a Roth IRA contribution and recently recharacterized to a tIRA - would have liked to do a "return of excess" on this but the time window to do that had passed). I like options #1 and 2, will followup with Fidelity if they will do #1. Thanks

[retiredjg]

I agree with retiredjg. The benefit of all of this, if any at all, is too small for the hassle.

Just remove the 2019 contribution plus associated earnings. Make sure they know you are asking for a return of your 2019 contribution. If you have earnings and will have a lower income 2020, wait and do this in January.

I don't think waiting till January will matter. The way I understand it, the income is reportable for 2019 no matter when you get it.

[retiredjg]

Many thanks retiredjg for detailing the various options, much appreciated.

Yes, this ended up being the only non-deductible contribution (made in 2018, originally as a Roth IRA contribution and recently recharacterized to a tIRA - would have liked to do a "return of excess" on this but the time window to do that had passed). I like options #1 and 2, will followup with Fidelity if they will do #1. Thanks

I'm going to have to re-read and re-think. I was talking about the 2019 contribution, not the 2018 contribution. Don't have time right now.

[kambyvk]

No worries, appreciate the already provided insights and help.

Just for info., for the 2019 contribution, Fidelity took me thru' a "return of excess" form and that amount has been credited to my cash account.

[retiredjg]

I'm wondering if there is a misunderstanding. Unless you did it way back in October, they could not recharacterize your 2018 contribution.

Or the misunderstanding could be on my part.

[kambyvk]

I did the recharacterization of the 2018 contribution in December 2019 (after my initial message posted 12/2/2019), Fidelity took me through it. Had I done it before October 2019, I could have done a "return of excess" on the 2018 contribution too.

[retiredjg]

That should have been too late to re-characterize as well. Not sure what is going on here.

[kambyvk]

That's what Fidelity suggested and what was done.
2018 contribution: recharacterize to tIRA (nondeductible)
2019 contribution: return of excess back to cash

[Alan S.]

That should have been too late to re-characterize as well. Not sure what is going on here.

Could be that as an ex patriot the filing deadline and the 6 month extended due dates were 6/17 and 12/15 respectively. If so Fidelity would have been able to recharacterize a 2018 contribution up to 12/15/2019. OP could call Fido and verify if that is how they recharacterized a 2018 contribution after 10/15.

[kambyvk]

Since many of you took the time to respond and make valuable suggestions, which I greatly appreciate, I feel obligated to bring this to closure with the following updated info. from a recent call to Fidelity. I had misunderstood what was actually done.

1. 2018 contribution: was handled as a return of excess
2. 2019 contribution: was recharacterized to tIRA (this was within the 10/2020 deadline).
I had the above backwards in the previous discussion and my apologies, on checking my records and subsequent call to Fidelity this was confirmed. I could have done a return of excess of the 2019 contribution also had I been more educated and switched-on on the potential ramifications. Major lesson learnt.
3. There is no way to undo the tIRA recharacterization - anything I do henceforth will involve form 8606 as pointed out to me correctly on this thread.
4. My employer 401K will accept a roll-in from my Rollover IRA but only the part of it that is deductible i.e. the portion without the funds from the recent Roth --> tIRA recharacterization. This is not easy to separate because of 3.

Sincere thanks again for everyone's help.

[lakpr]

4. My employer 401K will accept a roll-in from my Rollover IRA but only the part of it that is deductible i.e. the portion without the funds from the recent Roth --> tIRA recharacterization. This is not easy to separate because of 3.

There is still hope! With 2018 excess contribution removed from your traditional IRA, the only non-deductible portion left in the IRA is whatever your 2019 contribution is. If it is $6000, then hold back $6000 in your IRA, and roll the rest of the pre-tax portion into your 401k. Remember that the earnings on your non-deductible contribution ARE pre-tax, so you can simply do the rollover of (total balance - 2019 contribution) to your 401k.

[retiredjg]

Since many of you took the time to respond and make valuable suggestions, which I greatly appreciate, I feel obligated to bring this to closure with the following updated info. from a recent call to Fidelity. I had misunderstood what was actually done.

1. 2018 contribution: was handled as a return of excess

So did you actually get this money ($6,500) back along with some earnings? I believe the earnings will be reported to the IRS as 2018 income and you may need to amend your 2018 tax return. Or they may just send you a bill? On more reflection, I think I remember something about they leave the earnings in there when excess contribution is removed? As you can see, I'm not real clear on this.

2. 2019 contribution: was recharacterized to tIRA (this was within the 10/2020 deadline).

So now there is a $6,500 non-deductible contribution in your IRA. Again, I think you have 4 choices.

• -Have them do a return of that contribution (along with associated earnings) and your IRA is back to only pre-tax money. That can be rolled into your old 401k if they will accept it and if you want to use the back door in the future.
  
  -Roll everything except the $6,500 basis into your old 401k and convert the $6,500 to Roth.
  
  -Leave it there, document it on a 2019 Form 8606, and all your future withdrawals will be pro-rated.
  
  -Leave it there, don't document it, and pay tax on this money a second time as you empty the IRA in retirement.

I could have done a return of excess of the 2019 contribution also had I been more educated and switched-on on the potential ramifications.

I think you can still do that. You now have a non-deductible contribution as if you put the money in the IRA in the first place. I don't know of any reason you cannot undo that....until October 2020. The earnings will come with it and those earnings need to be added to your 2019 taxable income.

3. There is no way to undo the tIRA recharacterization - anything I do henceforth will involve form 8606 as pointed out to me correctly on this thread.

Again, I'm not sure that is correct. Why do you think that?

4. My employer 401K will accept a roll-in from my Rollover IRA but only the part of it that is deductible i.e. the portion without the funds from the recent Roth --> tIRA recharacterization. This is not easy to separate because of 3.

The IRS's ruling or guidance is that money taken out of the IRA and put in a 401k is considered to be pre-tax as long as you leave an amount equal to or greater than your basis in the IRA.

[kambyvk]

4. My employer 401K will accept a roll-in from my Rollover IRA but only the part of it that is deductible i.e. the portion without the funds from the recent Roth --> tIRA recharacterization. This is not easy to separate because of 3.

There is still hope! With 2018 excess contribution removed from your traditional IRA, the only non-deductible portion left in the IRA is whatever your 2019 contribution is. If it is $6000, then hold back $6000 in your IRA, and roll the rest of the pre-tax portion into your 401k. Remember that the earnings on your non-deductible contribution ARE pre-tax, so you can simply do the rollover of (total balance - 2019 contribution) to your 401k.

This would be the way to go but is complicated by me living overseas. I have to file taxes in 2 countries and although US and the country I live in have a double taxation avoidance agreement, there are many things which simply don't exist here and therefore are treated arbitrarily to fit the instruments/system they do have here for tax purposes. For example, while there are employee provident funds (similar to 401K) there are no IRAs and by extension Roth IRAs. Any roll-in from the Rollover IRA back into 401K could be viewed as a taxable event - they tend to take an accrual mindset esp. when dealing with things they are unfamiliar with.

[kambyvk]

retiredjg: Yes, I did get the $6500 back from 2018 to my cash account. They (Fidelity) advised me to leave the earnings on the contribution in the Roth IRA as IRS guidelines are unclear on how to treat them.

Options 3 or 4 are my best bets given that the nondeductible portion in the Rollover IRA is a small fraction of the total.

I explored doing a return of excess of the 2019 recharacterization with Fidelity and was told this can't be done. I was also told, however, to consult a CPA. My former employer still offers services of a Big 5 firm to do my taxes in US and here even though I have been retired for 2+ years due to continuing tax related matters from my expat service years. I don't get the full service advice from them as their remit is to file my taxes and not delve too much into specific (and somewhat complicated matters) stemming from my personal income matters. I am seriously considering hiring my own CPA, in addition, to get more personalized advice.

[retiredjg]

Options 3 or 4 are my best bets given that the nondeductible portion in the Rollover IRA is a small fraction of the total.

Certainly the easiest route since taxes from two countries are involved. If your IRA is large, this tiny little contribution is not going to make a significant change in the taxability of your withdrawals and it will require you to do an extra tax form every year you make a withdrawal or conversion until the IRA is empty. (Meaning, I'd be considering option 4 myself.)

I explored doing a return of excess of the 2019 recharacterization with Fidelity and was told this can't be done.

I believe this is incorrect. First, this was not an excess contribution - you were eligible to make it but you no longer want to. Second, a contribution can be returned to you (as if it never happened) until October of the following year. To my knowledge, the fact that it was recharacterized does not change this, but that might be a question for Alan S. to answer.

I wonder if the rep was getting re-characterization and conversion mixed up. I believe it is correct that once a conversion happens, you cannot get your contribution back.

See page 31 of PUblication 590a for information about return of a contribution before the due date.

https://www.irs.gov/pub/irs-pdf/p590a.pdf

Again, if your rollover IRA is large, I'm not sure it is worth this trouble. Unlike the excess contribution, It will result in the return of the associated earnings and those earnings will need to be reported on your 2019 taxes.