Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

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mask107
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Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 5:56 pm

I overcontributed by $5500 for tax year 2016 and have until the tax deadline which is in a few days to remove the proceeds. The problem is my earnings on the excess comes out to be $15000 out of a total account value of $50000 after I contributed and when I do the math I would have to pay taxes on $2000 or so if I withdraw. I was wondering should I:

1) Leave the amount in and pay the 6% penalty. Then withdraw the excess after a year

2) Withdraw the full amount before the deadline and pay 30% taxes plus 10% for early withdrawal

3) Withdraw excess and apply the earnings for next year's contribution

My tax bracket for the year is 30% by the way.

Also, I am currently unemployed and studying so I am not sure whether I will have any earned income for the year 2017 to contribute again to a Roth IRA for 2017.

Also, if I withdraw the whole excess amount next year, would you categorize it as a excess removal or a regular distribution if I do not apply the excess to 2017 contribution? And would I pay taxes on the earnings if I wait a year?
Last edited by mask107 on Thu Apr 13, 2017 6:22 pm, edited 1 time in total.

Geologist
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Geologist » Thu Apr 13, 2017 6:07 pm

As I understand it, the 6% excise tax is not a one-time penalty for your excess contribution, but an annual assessment. That is, you will owe 6% every year until you remove the excess contribution.

I'm also not sure how you could have contributed $5500 in 2016 and managed to have $15,000 in earnings on that $5500 since your contribution, which could have been no earlier than January 2, 2016.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 6:15 pm

I already had $30000 in the account to work with and I had a really good year. Also I plan to withdraw the excess only a year after and not wait too long

Alan S.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Alan S. » Thu Apr 13, 2017 6:38 pm

In round numbers if you had 30k in the account, then made a new contribution of 5.5k, your opening balance is 35.5k. Your closing balance is 50k and this is a 41% gain.

41% of 5500 = 2255. Your earnings on a corrective distribution would only be 2255.
2255*40%= 902 additional income tax

6% of 5500 = 330. With these numbers paying the excise tax is obviously preferable. A 15% gain is the break even at your tax rate with the 10% penalty applicable.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 6:43 pm

Hi Alan! Glad you answered! You have been giving great advice in the past and am happy you answered my thread. I was wondering if I wait a year and withdraw the $5500, will I have to pay an extra 10% for early withdrawal? Also do I select the $5500 withdrawal as an excess distribution withdrawal or a regular withdrawal after a year has past?

Thanks

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celia
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Thu Apr 13, 2017 6:53 pm

You need to remove the $5,500 and the earnings on the $5,500 since it was contributed. I don't know how you got your other numbers and it is irrelevant how much was in the account before that. You need to call up the custodian and ask for an "Excess Contribution" to be removed. (Use that term since it means you weren't eligible to contribute as much as you did. You apparently were only eligible to contribute $0.) They will calculate the earnings that go with it, but I suspect you only have earnings of no more than 10% (or $550).

The withdrawal will go back to taxable as if the contribution never occurred. Only the gains will be taxed.

mask107 wrote:1) Leave the amount in and pay the 6% penalty. Then withdraw the excess after a year
Why pay a penalty for being late? You'll have to remove it anyway if you didn't have earned income last year. The gains will most likely increase.

2) Withdraw the full amount before the deadline and pay 30% taxes plus 10% for early withdrawal
This is not a "withdrawal". It is un-doing a transaction.

3) Withdraw excess and apply the earnings for next year's contribution
You can do anything you want with it after it returns to taxable.

My tax bracket for the year is 30% by the way.

Also, I am currently unemployed and studying so I am not sure whether I will have any earned income for the year 2017 to contribute again to a Roth IRA for 2017.
I guess you can either take a chance and make an "Excess Contribution" again and be prepared to un-do it next year, else earn some money by working. To make it simpler to understand, if you make a new contribution, why not put it in a new IRA so the money is kept separate from your older IRA. Then if you don't have any earned income this year, when you remove the "Excess Contribution", the account will return to 0.

Also, if I withdraw the whole excess amount next year, would you categorize it as a excess removal or a regular distribution if I do not apply the excess to 2017 contribution? And would I pay taxes on the earnings if I wait a year?
Since you are going to ask for a removal of an "Excess Contribution" (use THOSE WORDS), the tax forms will be coded as to what kind of transaction this is. You will pay taxes for the year the gains were removed.

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celia
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Thu Apr 13, 2017 7:00 pm

Alan S. wrote:In round numbers if you had 30k in the account, then made a new contribution of 5.5k, your opening balance is 35.5k. Your closing balance is 50k and this is a 41% gain.

This is true ONLY if all the contributions were Excess Contributions. If only $5,500 is Excess Contributions (only done for one year), think of it as if it had been put into a separate account. You only have to pay taxes on the part of the gain that goes with the $5,500. You don't have to pay taxes on the gains on the other $30K if they were contributed in earlier years when you worked and were eligible to contribute. Those gains can remain with the $30K.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Katietsu » Thu Apr 13, 2017 7:38 pm

You have until October 15 to withdraw the excess contribution.

I would file an extension which will give you the full set of options through October 15. I am not even sure you will be able to find out what your exact earnings on your excess contribution would be before next Tuesday. You will also have a better idea of your 2017 situation with a bit more time.

As Celia pointed out, the 6% penalty is per year until the excess is removed or applied to a future year. If you pay the 6% for 2016 and are not eligible in 2017 to make a contribution, you would owe another 6% if the excess contribution remained.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 8:07 pm

Hi Celia, thank you for answering, but I'm confused by your replies:

1) Leave the amount in and pay the 6% penalty. Then withdraw the excess after a year
Why pay a penalty for being late? You'll have to remove it anyway if you didn't have earned income last year. The gains will most likely increase.
I was over the MAGI and had a high earned income for the year 2016, I do not have earned income only for 2017. Was hoping to remove excess come 2017 tax season or in December of 2016 so I can pay 6% compared to the 30% income tax on the $2k or so of calculated earnings

2) Withdraw the full amount before the deadline and pay 30% taxes plus 10% for early withdrawal
This is not a "withdrawal". It is un-doing a transaction.
I have earnings caused by the excess I have to take from the account

3) Withdraw excess and apply the earnings for next year's contribution
You can do anything you want with it after it returns to taxable.
I want to pay the least amount of taxes possible so if I withdraw excess do I have to pay taxes on the earnings still if I carryover it for 2017? Technically since I made an excess contribution will the earnings be taxed if I chose to apply it right away for the 2017 contribution? I haven't contributed to 2017 yet

My tax bracket for the year is 30% by the way.

Also, I am currently unemployed and studying so I am not sure whether I will have any earned income for the year 2017 to contribute again to a Roth IRA for 2017.
I guess you can either take a chance and make an "Excess Contribution" again and be prepared to un-do it next year, else earn some money by working. To make it simpler to understand, if you make a new contribution, why not put it in a new IRA so the money is kept separate from your older IRA. Then if you don't have any earned income this year, when you remove the "Excess Contribution", the account will return to 0.
Main obstacle for me is trying to avoid paying on earnings this year since my tax bracket for 2017 might be a lot lower at 10% compared to 30% for 2016

Also, if I withdraw the whole excess amount next year, would you categorize it as a excess removal or a regular distribution if I do not apply the excess to 2017 contribution? And would I pay taxes on the earnings if I wait a year?
Since you are going to ask for a removal of an "Excess Contribution" (use THOSE WORDS), the tax forms will be coded as to what kind of transaction this is. You will pay taxes for the year the gains were removed.
So if I wait a year, I still would have to pay taxes on the earnings? I thought the 6% fee and the tax on earnings was mutually exclusive. If I paid one, I wouldn't have to pay the other?

Thanks!

Tanelorn
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Tanelorn » Thu Apr 13, 2017 8:10 pm

Ideally you would work enough in 2017 to have $5500 in earned income. Then you can pay the excess contribution 6% penalty for 2016 and then not make an additional 2017 contribution and use that right to offset the 2016 excess so the penalty stops after just one year. Then you get to keep all the gains inside the IRA.
Last edited by Tanelorn on Thu Apr 13, 2017 8:14 pm, edited 1 time in total.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 8:12 pm

Ideally you would work enough in 2017 to have $5500 in earned income. Then you can pay the excess contribution 6% penalty for 2016 and then not make an additional 2017 contribution and use that to right to offset the 2016 excess so the penalty stops after just one year. Then you get to keep all the gains inside the IRA.

I am considering a career change so I will not be working in 2017. What are my options then? I can just withdraw 5500 as a regular distribution without the earnings (the excess) in 2017 and be fine right? I just don't want to pay 30% tax for 2016 on the withdrawal

DSInvestor
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by DSInvestor » Thu Apr 13, 2017 8:16 pm

What about recharacterization of the excess 2016 Roth IRA contribution to 2016 Traditional IRA contribution. This will move the contribution and associated earnings into Traditional IRA. Convert everything in Traditional IRA to Roth IRA. The converted amount in excess of IRA basis will be taxable in 2017 which may not be a problem given that you're not working in 2017.

Tanelorn
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Tanelorn » Thu Apr 13, 2017 8:24 pm

mask107 wrote:I am considering a career change so I will not be working in 2017. What are my options then? I can just withdraw 5500 as a regular distribution without the earnings (the excess) in 2017 and be fine right? I just don't want to pay 30% tax for 2016 on the withdrawal

if you want to stop the penalties, you eventually have to either take out the excess contributions and their associated earnings (and pay tax on the earnings when you do), or you have to earn enough income to have the right to make the contribution. If you think your tax bracket is very high for 2016 and will be much lower in 2017, that's another reason to consider paying the 6% excess contribution to delay taking out your taxable excess associated earnings until 2017.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Alan S. » Thu Apr 13, 2017 10:22 pm

Tanelorn wrote:
mask107 wrote:I am considering a career change so I will not be working in 2017. What are my options then? I can just withdraw 5500 as a regular distribution without the earnings (the excess) in 2017 and be fine right? I just don't want to pay 30% tax for 2016 on the withdrawal

if you want to stop the penalties, you eventually have to either take out the excess contributions and their associated earnings (and pay tax on the earnings when you do), or you have to earn enough income to have the right to make the contribution. If you think your tax bracket is very high for 2016 and will be much lower in 2017, that's another reason to consider paying the 6% excess contribution to delay taking out your taxable excess associated earnings until 2017.


Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings). This can be done anytime in 2017 as long as the request does not refer to a return of the 2016 contribution. Do not even mention an excess contribution or a 2016 contribution to the custodian, just ask for a distribution of 5500 flat. That will result in a 1099R that is not coded as a return of any specific contribution. But it is safer to wait until after 10/15 since after that date there is no risk of the custodian misinterpreting the request and do the earnings calc. This also allows more time for the contribution to generate tax free earnings.

When this is done, the only tax due with be the 2016 6% excise tax. The gains remain in the Roth, so they do NOT have to be taken out at any time. Conversely, if the contribution is returned with earnings, the earnings must be taxable in the year the contribution was made. If the earnings were 40% of the contribution, it would probably be wise to pay the excise tax for one year even if your tax rate was 0 for the year of the contribution since you are banking 2200 of tax free earnings for $330. That equates to a conversion at a rate of 15% which is usually a winner.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Thu Apr 13, 2017 11:29 pm

Many thanks to all of you, especially Alan. Cheers. I will withdraw near December in 2017

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celia
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 1:01 am

OP, I assumed you didn't work in 2016 or 2017 when I first answered you and the 30% rate applied to other income (investments, rentals, stock options,...) But whether you worked or not, you still were not eligible to contribute to a Roth. Were you eligible to make a non-deductible contribution to a TIRA and then convert it to Roth without having any other non-Roth IRAs at the end of 2016 (since the pro-rata rule would apply on the conversion)? If so, it may be to your advantage to recharacterize to a traditional IRA instead.

terminology: I am intentionally using the term "gains" for any growth on the $5,500 instead of "earnings" because I want to distinguish it from the "earnings" received from working.

I was over the MAGI and had a high earned income for the year 2016, I do not have earned income only for 2017. Was hoping to remove excess come 2017 tax season or in December of 2016 so I can pay 6% compared to the 30% income tax on the $2k or so of calculated earnings

If you are thinking you can pay 6% instead of 30% on your gains, that does not work. You will have to pay taxes at your regular tax rate on those gains sometime. You can't just keep them in the Roth as Alan suggests because you weren't supposed to make that contribution that the gains are based on. The IRS will know it because the custodians will mail Form 5498 to the IRS and you in May. It will show your Roth contribution and the IRS will then be contacting you since it knows your 2016 wages. And the $5,500 you then withdraw (without the gains) will be coded differently than a removal of an Excess Contribution. So the best thing to do is clean this up properly as if you accidentally made the Excess Contribution (instead of trying to take advantage of the rules, which doesn't work). Here is a basic explanation from Vanguard:
https://investor.vanguard.com/ira/excess-contribution

At the bottom of the page, it talks about the penalties:
Vanguard wrote:What the penalty could be

The IRS will charge you a 6% penalty tax on the excess amount for each year in which you don't take action to correct the error.

For example, if you contributed $1,000 more than you were allowed, you'd owe $60 each year until you correct the mistake.

If you remove your excess contribution plus earnings before either the April 15 or October 15 deadline, the earnings are taxed as ordinary income.

And if you're under 59½, you'll be subject to a 10% early withdrawal penalty.

Play around with a copy of your tax software data file to see how it handles it if you withdraw the Excess Contributions and gains before filing. Assume your gains are $2000, if that's what you calculate (but I think it will be closer to $550**). Then to see how tax software handles it if you withdraw after October 15, start over with another copy of your tax software data file and pretend that you weren't eligible for a Roth contribution in 2015, it has $2,000 in gains, and you just now withdrew the Excess Contribution and gains. If you clean this up now, you will at least avoid the 6% penalty and the taxable gains will likely be smaller than in a year from now. (Next year the gains will be taxed at: 6% + <current tax rate> + 10%.)

--------------------------------------------------------------------------
**Here's how I would get a close calculation of the gains:
For the day the contribution was received, find out what the account value was (not including the contributions) and the percent of the account the contribution represents. The gains received up to that time all belong to the previous contributions.

Now look at the current value of the account. Subtract the value on the day of the contribution (not counting the contribution). This is the increase in the account value since then. It is composed of:
* the contribution
* gains attributed to the contribution
* gains attributed to the previous holdings (before the contribution was made)

So subtract the contribution. You are left with only gains since the day the contribution was made. Multiply those gains by the percent the contribution was on contribution day. That is the amount that is attributed to the Excess Contribution. The remaining gains are for the previous holdings.

Example: On the day of contribution, the original $30K was then worth $40K. The $5,500 contribution was made and is 12% of the value of the account (5,500/45,500). Say, today the account is worth $50K, so there is an increase of $10K since the day of contribution. That $10K is broken down as:
* 5,500 contribution <--Excess Contribution to be removed
* 544 in gains attributed to the contribution (12% of 4,500) <--gains to also be removed
* 3,956 in gains attributed to the previous holdings (88% of 4,500)
(Was I close??? :beer :beer )

Calculate it this way, even if you have more than one fund in the account, since Vanguard is required to calculate it like this. This is how recharacterizations are also calculated. BTW, is it worth messing around to save extra taxes on that $544 gain? I would just clean this up properly and move on.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 9:08 am

To the OP. Do exactly as Alan S. suggests. He IS the authority on these issues. Do not let celia confuse you.

celia wrote:If you are thinking you can pay 6% instead of 30% on your gains, that does not work. You will have to pay taxes at your regular tax rate on those gains sometime.[/b] You can't just keep them in the Roth as Alan suggests because you weren't supposed to make that contribution that the gains are based on.

Celia you are flat out wrong on this issue and it is not the first time on retirement plan issues. Please defer to Alan unless to you have a specific cite to contradict him.

There are three options to avoid paying taxes on the earnings of 2016 excess Roth IRA contributions:
  1. Remove the excess contributions and associated earnings by the tax filing deadline (4/18/17) including extensions (10/16/17).
  2. Pay the 6% excise tax calculated on 2016 Form 5329 and make a qualified distribution in an amount >= the excess contribution amount before 12/31/17. Reference: Form 5329 Instructions, page 6, Line 20 - enter the amount from Form 8606, line 19, plus any qualified distributions. Distributions of Roth IRA contributions are always qualified distributions.
  3. Pay the 6% excise tax calculated on 2016 Form 5329 and make a qualified distribution of the entire balance if it is < the excess contribution amount before 12/31/17. File a 2017 Form 5329 showing the excess contribution from 2016 on line 20 even though it is greater than the Roth IRA balance, cancelling the excess contribution on line 22. Reference: Form 5329 Instructions, page 6, Line 20 - if you withdrew the entire balance of all of your Roth IRAs, do not enter less than the amount on Form 5329, line 18.
In these circumstances with the OP's substantial earnings, the OP should most definitely use option 2.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 12:10 pm

I am so confused lol. I'll just withdraw it then

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by DSInvestor » Fri Apr 14, 2017 12:22 pm

mask107 wrote:I am so confused lol. I'll just withdraw it then


If you expect no income for 2017 tax year, why not consider recharacterizing your 2016 Roth IRA contribution to a 2016 Traditional IRA contribution? Once the recharacterization is complete, convert it back to Roth IRA. The conversion is taxable in 2017 but the tax hit will not be bad if you will have no other income for 2017. If you were covered by an employer plan for 2016, your high income would make the Traditional IRA non-deductible (IRA basis). Assuming no other non-Roth IRA assets, your IRA basis will be fully consumed by the conversion. If you $15000 TIRA with $5500 IRA basis, the $15000 conversion will be $5500 non-taxable and $10,500 taxable.

If you have $10,500 AGI, your taxable income may be zero.
Taxable Income = AGI - deductions - exemptions

Taxable Income = 10,500 - 6350 - 4050 = 100
Fed Tax is $10.

If your TIRA is 20,000 with $5500 IRA basis, then your AGI would be 14,500, resulting in taxable Income of $4100 -> Fed Tax of $410.

The advantage of recharacterization and conversion is that you work around the Roth IRA excess contribution and get to keep the money in the Roth IRA.
Last edited by DSInvestor on Fri Apr 14, 2017 12:30 pm, edited 2 times in total.

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celia
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 12:22 pm

Spirit Rider wrote:Celia you are flat out wrong on this issue and it is not the first time on retirement plan issues. Please defer to Alan unless to you have a specific cite to contradict him.

The problem with Alan's solution is that it does not acknowledge there is an Excess Contribution. The contribution fits the IRS definition of Excess Contribution. The definition and correction are described here by the IRS:
https://www.irs.gov/publications/p590a/ ... 1000231024

IRS wrote:Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

Spirit Rider, Where did you find an official source that acknowledges your 3 options? I would like to know more about this, if there are other legal options. Following Alan's suggestion would still leave the OP with an Excess Contribution that (s)he would still have to remove in the future (because the 1099-R would be coded differently). And if this was an approved method for making this kind of correction, I wonder why it isn't discussed in this forum.

edit: fix broken link
Last edited by celia on Fri Apr 14, 2017 1:23 pm, edited 1 time in total.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by petiejoe » Fri Apr 14, 2017 12:28 pm

You're probably better off recharacterizing the 2016 contributions (at least the amount that's over your income limit) to a traditional IRA. This is not a taxable event. As far as the IRS is concerned, it's as though you originally made the contributions to the traditional IRA. Your bank should be able to handle this fairly easily (although with the imminent tax filing deadline, you may want to file an extension to allow time for them to finish this). Since you don't plan to have income this year, you can then convert the traditional IRA to a Roth IRA without paying much (if any) tax.

mask107
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 12:29 pm

DSInvestor wrote:
mask107 wrote:I am so confused lol. I'll just withdraw it then


If you expect no income for 2017 tax year, why not consider recharacterizing your 2016 Roth IRA contribution to a 2016 Traditional IRA contribution? Once the recharacterization is complete, convert it back to Roth IRA. The conversion is taxable in 2017 but the tax hit will not be bad if you will have no other income for 2017. If you were covered by an employer plan for 2016, your high income would make the Traditional IRA non-deductible (IRA basis). Assuming no other non-Roth IRA assets, your IRA basis will be fully consumed by the conversion. If you $15000 TIRA with $5500 IRA basis, the $15000 conversion will be $5500 non-taxable and $10,500 taxable.

If you have $10,500 AGI, your taxable income may be zero.
Taxable Income = AGI - deductions - exemptions

Taxable Income = 10,500 - 6350 - 4050 = 100
Fed Tax is $10.



What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?

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celia
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 12:34 pm

DSInvestor wrote:
mask107 wrote:I am so confused lol. I'll just withdraw it then

If you expect no income for 2017 tax year, why not consider recharacterizing your 2016 Roth IRA contribution to a 2016 Traditional IRA contribution? Once the recharacterization is complete, convert it back to Roth IRA. The conversion is taxable in 2017 but the tax hit will not be bad if you will have no other income for 2017.

Yes, This is the simple solution to achieve what I think the OP wants.

The downside is that if (s)he has other non-Roth IRAs, the entire conversion will be pro-rated with the other traditional IRAs. It will also leave some traditional IRA "basis" that will have to be tracked each year until all the traditional IRAs are emptied out. But this can be mitigated if the OP get a future 401K that allows rollovers into the plan of personal IRAs. But some 401K plans only allow roll-overs of IRAs that originated from a previous employer plan and haven't been co-mingled with personal contributions.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by DSInvestor » Fri Apr 14, 2017 12:35 pm

mask107 wrote:
DSInvestor wrote:
mask107 wrote:I am so confused lol. I'll just withdraw it then


If you expect no income for 2017 tax year, why not consider recharacterizing your 2016 Roth IRA contribution to a 2016 Traditional IRA contribution? Once the recharacterization is complete, convert it back to Roth IRA. The conversion is taxable in 2017 but the tax hit will not be bad if you will have no other income for 2017. If you were covered by an employer plan for 2016, your high income would make the Traditional IRA non-deductible (IRA basis). Assuming no other non-Roth IRA assets, your IRA basis will be fully consumed by the conversion. If you $15000 TIRA with $5500 IRA basis, the $15000 conversion will be $5500 non-taxable and $10,500 taxable.

If you have $10,500 AGI, your taxable income may be zero.
Taxable Income = AGI - deductions - exemptions

Taxable Income = 10,500 - 6350 - 4050 = 100
Fed Tax is $10.



What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?


You'll likely have to mail in a recharacterization form to your IRA custodian. The deadline for recharacterizing is tax filing deadline plus extensions. If your IRA is at Vanguard, here's a link to the page where you can find recharacterization form:
https://personal.vanguard.com/us/litera ... t=recharac

Fairmark page on Recharacterizations:
http://fairmark.com/retirement/roth-acc ... rizations/

The recharacterization of the contribution will make it as though you had contributed to Traditional IRA all along. Traditional IRA has no income limit that disallows contribution but you do need to have compensation. The conversion back to Roth IRA can be done any time later, even years later if you wish. Make sure that you tell your tax software/tax return that you contributed to Traditional IRA so form 8606 is added to track IRA basis in the event that your TradIRA contribution is non-deductible.

BTW, my suggestion for recharacterization assumes that you had eligible compensation for IRA contributions but your MAGI was too high to allow Roth IRA contributions. In this case, you'd be eligible for Traditional IRA contributions and recharacterization of Roth IRA contribution to Traditional IRA contribution would work in this case.

If your excess contribution to Roth IRA was caused by something else like you contributed $5500 twice to two different Roth IRA accounts at different custodians for tax year 2016, recharacterization will not work.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 12:48 pm

mask107 wrote:What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?

If you file by April 18, you can still recharacterize by October 15. Vanguard now does this by phone. Call them up, the same as if you were removing the Excess Contribution. The earnings (gains) will be the same either way. Just beware of what you may be getting into for trying to get a lower tax rate on your significant earnings of $550.

If you don't have any traditional IRAs of any kind, I would recommend it.
If you have some traditional IRAs, I would not recommend it since you will have years of tracking the basis unless the value of those accounts is small. Why not convert the entire accounts this year, since your tax rate will be lower? Then you won't have to track the basis!


Mask, When you get done with whatever you decide, could you return and tell us how much those earnings are? The size of those earnings COULD make a difference in how future readers fix their own Excess Roth Contributions.
Last edited by celia on Fri Apr 14, 2017 12:54 pm, edited 1 time in total.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 12:52 pm

DSInvestor wrote:
mask107 wrote:
DSInvestor wrote:
mask107 wrote:I am so confused lol. I'll just withdraw it then


If you expect no income for 2017 tax year, why not consider recharacterizing your 2016 Roth IRA contribution to a 2016 Traditional IRA contribution? Once the recharacterization is complete, convert it back to Roth IRA. The conversion is taxable in 2017 but the tax hit will not be bad if you will have no other income for 2017. If you were covered by an employer plan for 2016, your high income would make the Traditional IRA non-deductible (IRA basis). Assuming no other non-Roth IRA assets, your IRA basis will be fully consumed by the conversion. If you $15000 TIRA with $5500 IRA basis, the $15000 conversion will be $5500 non-taxable and $10,500 taxable.

If you have $10,500 AGI, your taxable income may be zero.
Taxable Income = AGI - deductions - exemptions

Taxable Income = 10,500 - 6350 - 4050 = 100
Fed Tax is $10.



What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?


You'll likely have to mail in a recharacterization form to your IRA custodian. The deadline for recharacterizing is tax filing deadline plus extensions. If your IRA is at Vanguard, here's a link to the page where you can find recharacterization form:
https://personal.vanguard.com/us/litera ... t=recharac

Fairmark page on Recharacterizations:
http://fairmark.com/retirement/roth-acc ... rizations/

The recharacterization of the contribution will make it as though you had contributed to Traditional IRA all along. Traditional IRA has no income limit that disallows contribution but you do need to have compensation. The conversion back to Roth IRA can be done any time later, even years later if you wish. Make sure that you tell your tax software/tax return that you contributed to Traditional IRA so form 8606 is added to track IRA basis in the event that your TradIRA contribution is non-deductible.

BTW, my suggestion for recharacterization assumes that you had eligible compensation for IRA contributions but your MAGI was too high to allow Roth IRA contributions. In this case, you'd be eligible for Traditional IRA contributions and recharacterization of Roth IRA contribution to Traditional IRA contribution would work in this case.

If your excess contribution to Roth IRA was caused by something else like you contributed $5500 twice to two different Roth IRA accounts at different custodians for tax year 2016, recharacterization will not work.


I only contributed once to any IRAs and the reason it was not allowed was because my magi was too high. All of it has been earned income

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by petiejoe » Fri Apr 14, 2017 1:02 pm

celia wrote:
mask107 wrote:What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?

If you file by April 18, you can still recharacterize by October 15. Vanguard now does this by phone. Call them up, the same as if you were removing the Excess Contribution. The earnings (gains) will be the same either way. Just beware of what you may be getting into for trying to get a lower tax rate on your significant earnings of $550.

If you don't have any traditional IRAs of any kind, I would recommend it.
If you have some traditional IRAs, I would not recommend it since you will have years of tracking the basis unless the value of those accounts is small. Why not convert the entire accounts this year, since your tax rate will be lower? Then you won't have to track the basis!


Mask, When you get done with whatever you decide, could you return and tell us how much those earnings are? The size of those earnings COULD make a difference in how future readers fix their own Excess Roth Contributions.


Since the OP is about to have a year of low or no earnings, 2017 would be the ideal time to do conversion of any existing traditional IRA anyway. If there's enough room to convert all of the traditional IRA this year, they would only have to consider the basis for one year.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by DSInvestor » Fri Apr 14, 2017 1:04 pm

mask107 wrote:I only contributed once to any IRAs and the reason it was not allowed was because my magi was too high. All of it has been earned income
That's great. You're eligible for Traditional IRA contribution. Recharacterization would work well to avoid your Roth IRA excess contribution. If you were covered by an employer plan, your high income would disallow the Traditional IRA deduction so it is critical that your 2016 tax return has your 2016 Traditional IRA contribution so form 8606 can be added to track your non-deductible contribution. This helps reduce the tax cost of conversion later. If you were not covered by an employer plan, your Traditional IRA contribution will be deductible (1040 line 32).

Your tax software may have something about recharacterization of IRA contribution. Not sure if you just enter a Traditional IRA contribution OR enter a Roth IRA contribution and recharacterization to with an attached explanatory note.

Here's a link to turbotax support page for Roth IRA recharacterization and conversion:
https://ttlc.intuit.com/questions/36929 ... conversion
Turbotax wrote:Roth IRA Recharacterization and Conversion
I ended up contributing to a Roth IRA in 2016, however earned over the income limit. I recharacterized my 2016 Roth IRA contributions to a Traditional IRA contribution for 2016, and then converted the 2016 Traditional IRA contributions to a Roth IRA in 2017. I also set up a backdoor Roth IRA for 2017.

Can Turbotax handle this situation? Do I need to do anything for my 2016 taxes? If so, how?

ANSWER
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Yes, TurboTax can handle this. In 2016 TurboTax, indicate that you made a Roth IRA contribution, then indicate that you switched/recharacterized it to a traditional IRA. TurboTax will either show this on Form 1040 line 32 or Form 1040A line 17 as a deductible traditional IRA contribution or will prepare Form 8606 to show your nondeductible traditional IRA contribution on line 14 which will carry forward to your 2017 tax return to reduce the taxable amount of your Roth conversion.

Since your Roth conversion occurred in 2017, it will be reported on your 2017 tax return.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 1:13 pm

mask107 wrote:I only contributed once to any IRAs and the reason it was not allowed was because my magi was too high. All of it has been earned income

I assume this means you also never had a rollover from a previous employer retirement plan into a traditional IRA. That IRA would also have to be considered.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 1:30 pm

petiejoe wrote:
celia wrote:
mask107 wrote:What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?

If you file by April 18, you can still recharacterize by October 15. Vanguard now does this by phone. Call them up, the same as if you were removing the Excess Contribution. The earnings (gains) will be the same either way. Just beware of what you may be getting into for trying to get a lower tax rate on your significant earnings of $550.

If you don't have any traditional IRAs of any kind, I would recommend it.
If you have some traditional IRAs, I would not recommend it since you will have years of tracking the basis unless the value of those accounts is small. Why not convert the entire accounts this year, since your tax rate will be lower? Then you won't have to track the basis!


Mask, When you get done with whatever you decide, could you return and tell us how much those earnings are? The size of those earnings COULD make a difference in how future readers fix their own Excess Roth Contributions.


Since the OP is about to have a year of low or no earnings, 2017 would be the ideal time to do conversion of any existing traditional IRA anyway. If there's enough room to convert all of the traditional IRA this year, they would only have to consider the basis for one year.


So should I do the conversation in 2016 before the deadline, or wait until 2017? When is the deadline? Is it April for tax deadline or october? I am not filinf an extension because I already filed my taxes, but should i file for an extention?

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by petiejoe » Fri Apr 14, 2017 1:34 pm

mask107 wrote:
petiejoe wrote:
celia wrote:
mask107 wrote:What are the steps to recharacterize a Roth IRA? And should I take action before the tax deadline or wait until it has passed?

If you file by April 18, you can still recharacterize by October 15. Vanguard now does this by phone. Call them up, the same as if you were removing the Excess Contribution. The earnings (gains) will be the same either way. Just beware of what you may be getting into for trying to get a lower tax rate on your significant earnings of $550.

If you don't have any traditional IRAs of any kind, I would recommend it.
If you have some traditional IRAs, I would not recommend it since you will have years of tracking the basis unless the value of those accounts is small. Why not convert the entire accounts this year, since your tax rate will be lower? Then you won't have to track the basis!


Mask, When you get done with whatever you decide, could you return and tell us how much those earnings are? The size of those earnings COULD make a difference in how future readers fix their own Excess Roth Contributions.


Since the OP is about to have a year of low or no earnings, 2017 would be the ideal time to do conversion of any existing traditional IRA anyway. If there's enough room to convert all of the traditional IRA this year, they would only have to consider the basis for one year.


So should I do the conversation in 2016 before the deadline, or wait until 2017? When is the deadline? Is it April for tax deadline or october? I am not filinf an extension because I already filed my taxes, but should i file for an extention?


Call your IRA company and straighten that out before the tax deadline. You need to do the recharacterization on the 2016 taxes. I'm not sure how quickly they'll be able to do the recharacterization (probably depends on the bank), so you may need to file for an extension on your taxes (first one's free!)

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 1:42 pm

DSInvestor wrote:
mask107 wrote:I only contributed once to any IRAs and the reason it was not allowed was because my magi was too high. All of it has been earned income
That's great. You're eligible for Traditional IRA contribution. Recharacterization would work well to avoid your Roth IRA excess contribution. If you were covered by an employer plan, your high income would disallow the Traditional IRA deduction so it is critical that your 2016 tax return has your 2016 Traditional IRA contribution so form 8606 can be added to track your non-deductible contribution. This helps reduce the tax cost of conversion later. If you were not covered by an employer plan, your Traditional IRA contribution will be deductible (1040 line 32).

Your tax software may have something about recharacterization of IRA contribution. Not sure if you just enter a Traditional IRA contribution OR enter a Roth IRA contribution and recharacterization to with an attached explanatory note.

Here's a link to turbotax support page for Roth IRA recharacterization and conversion:
https://ttlc.intuit.com/questions/36929 ... conversion
Turbotax wrote:Roth IRA Recharacterization and Conversion
I ended up contributing to a Roth IRA in 2016, however earned over the income limit. I recharacterized my 2016 Roth IRA contributions to a Traditional IRA contribution for 2016, and then converted the 2016 Traditional IRA contributions to a Roth IRA in 2017. I also set up a backdoor Roth IRA for 2017.

Can Turbotax handle this situation? Do I need to do anything for my 2016 taxes? If so, how?

ANSWER
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Yes, TurboTax can handle this. In 2016 TurboTax, indicate that you made a Roth IRA contribution, then indicate that you switched/recharacterized it to a traditional IRA. TurboTax will either show this on Form 1040 line 32 or Form 1040A line 17 as a deductible traditional IRA contribution or will prepare Form 8606 to show your nondeductible traditional IRA contribution on line 14 which will carry forward to your 2017 tax return to reduce the taxable amount of your Roth conversion.

Since your Roth conversion occurred in 2017, it will be reported on your 2017 tax return.


My employer plan did not have an IRA plan this year. I had a prior IRA plan from two years ago however. Should I recharacterize before the deadline or wait until after the tax deadline at recharacterize for 2017 tax season?

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by petiejoe » Fri Apr 14, 2017 1:50 pm

mask107 wrote:
DSInvestor wrote:
mask107 wrote:I only contributed once to any IRAs and the reason it was not allowed was because my magi was too high. All of it has been earned income
That's great. You're eligible for Traditional IRA contribution. Recharacterization would work well to avoid your Roth IRA excess contribution. If you were covered by an employer plan, your high income would disallow the Traditional IRA deduction so it is critical that your 2016 tax return has your 2016 Traditional IRA contribution so form 8606 can be added to track your non-deductible contribution. This helps reduce the tax cost of conversion later. If you were not covered by an employer plan, your Traditional IRA contribution will be deductible (1040 line 32).

Your tax software may have something about recharacterization of IRA contribution. Not sure if you just enter a Traditional IRA contribution OR enter a Roth IRA contribution and recharacterization to with an attached explanatory note.

Here's a link to turbotax support page for Roth IRA recharacterization and conversion:
https://ttlc.intuit.com/questions/36929 ... conversion
Turbotax wrote:Roth IRA Recharacterization and Conversion
I ended up contributing to a Roth IRA in 2016, however earned over the income limit. I recharacterized my 2016 Roth IRA contributions to a Traditional IRA contribution for 2016, and then converted the 2016 Traditional IRA contributions to a Roth IRA in 2017. I also set up a backdoor Roth IRA for 2017.

Can Turbotax handle this situation? Do I need to do anything for my 2016 taxes? If so, how?

ANSWER
1 person found this helpful
Yes, TurboTax can handle this. In 2016 TurboTax, indicate that you made a Roth IRA contribution, then indicate that you switched/recharacterized it to a traditional IRA. TurboTax will either show this on Form 1040 line 32 or Form 1040A line 17 as a deductible traditional IRA contribution or will prepare Form 8606 to show your nondeductible traditional IRA contribution on line 14 which will carry forward to your 2017 tax return to reduce the taxable amount of your Roth conversion.

Since your Roth conversion occurred in 2017, it will be reported on your 2017 tax return.


My employer plan did not have an IRA plan this year. I had a prior IRA plan from two years ago however. Should I recharacterize before the deadline or wait until after the tax deadline at recharacterize for 2017 tax season?


Recharacterize now for 2016. Don't wait. Call your bank and get the ball rolling on it. Separately you may have to file an extension for your taxes, but there's no value in waiting to do the recharacterization.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 2:17 pm

mask107 wrote:So should I do the conversation in 2016 before the deadline, or wait until 2017? When is the deadline? Is it April for tax deadline or october? I am not filinf an extension because I already filed my taxes, but should i file for an extention?

You don't need to file for an extension. A recharacterization won't change your tax bill. But you will need to file Form 8606 and mail it in separately to report your basis (non-deductible part of the tIRA) of $5,500. You can mail that in by itself to the same address as your paper return would have been sent to. This is needed so that when you do the conversion, the IRS will already know that $5,500 was previously taxed and only the gains would then be taxed.

If you have any money in employer retirement plans (eg. 401k), you might want to see if you can rollover $50K or so (the amount you would then be willing to convert to Roth and pay taxes on in 2017). This would be beneficial if you are in a low tax bracket this year. Why not allow those dollars to grow tax-free inside of a Roth instead?

---------------------------
Notes for Form 8606:
I think it is possible to fill out the Form for this with your tax software, but I haven't figured out how (without filing a 1040).
You can print this out, preferably double-sided: https://www.irs.gov/pub/irs-pdf/f8606.pdf
and put 5,500 on lines 1, 3, and 14.
Sign. Mail. That's it! Keep a copy with your 2016 tax return so you don't forget about it when you do taxes next year.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 2:36 pm

celia wrote:
Spirit Rider wrote:Celia you are flat out wrong on this issue and it is not the first time on retirement plan issues. Please defer to Alan unless to you have a specific cite to contradict him.

The problem with Alan's solution is that it does not acknowledge there is an Excess Contribution. The contribution fits the IRS definition of Excess Contribution. The definition and correction are described here by the IRS:
https://www.irs.gov/publications/p590a/ ... 1000231024

Alan's solution most definitely acknowledges there is an excess contribution. It is in the first line your link, presented below. You file Form 5329, calculating and paying the excise tax. This most certainly acknowledges and reports the excess contribution.

A 6% excise tax applies to any excess contribution to a Roth IRA.

IRS wrote:Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

Spirit Rider, Where did you find an official source that acknowledges your 3 options? I would like to know more about this, if there are other legal options. Following Alan's suggestion would still leave the OP with an Excess Contribution that (s)he would still have to remove in the future (because the 1099-R would be coded differently). And if this was an approved method for making this kind of correction, I wonder why it isn't discussed in this forum.

If you would have fully read my previous response instead of doubling down on your incorrect insistence that this can not be done. You would have seen my explicit reference to the Form 5329 instructions that show a simple Roth IRA qualified distribution in 2017 can remove the 2016 excess contribution carry-forward before an additional excise tax is due.

Just because the majority of people here want to suggest a removal of the excess contributions and earnings or a recharacterization and conversion, doesn't make them correct that they are the only viable or even best options. That is the good and bad of this forum. Any member can express their opinion, but they do not have the right to incorrect facts.

In both of these options the substantial earnings are taxable income. In Alan's solution they are not. When it comes to retirement plan issues my money is always on Alan unless and until somebody provides absolute proof otherwise. No one has done that and I have provided absolute proof that he is right and you are wrong.

I see many incorrect facts stated on this forum and have even done it a few times myself. The main reason is that people tend to only know what they know, and not what they don't know. Disregarding the issue and the person who made the quote, one of my favorite quotes is directly applicable here "as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don't know we don't know."

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 3:05 pm

Spirit Rider wrote:
celia wrote:The problem with Alan's solution is that it does not acknowledge there is an Excess Contribution. The contribution fits the IRS definition of Excess Contribution. The definition and correction are described here by the IRS:
https://www.irs.gov/publications/p590a/ ... 1000231024

Alan's solution most definitely acknowledges there is an excess contribution. It is in the first line your link, presented below. You file Form 5329, calculating and paying the excise tax. This most certainly acknowledges and reports the excess contribution.

I admit I make mistakes, and want to know the correct answer when I do, but in this case, after you and Alan posted, I went back to verify my understanding at the IRS website. Alan's post was about taking a regular distribution instead of an Excess Contribution:
Alan S. wrote:Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings). This can be done anytime in 2017 as long as the request does not refer to a return of the 2016 contribution. Do not even mention an excess contribution or a 2016 contribution to the custodian, just ask for a distribution of 5500 flat. That will result in a 1099R that is not coded as a return of any specific contribution.

In other words, the 1099-R will not be coded as an Excess Contribution being removed. By IRS definition, an "Excess Contribution" has to have its earnings removed also. If you take a regular distribution, you will still have to remove the Excess Contribution.

I added the bold emphasis above.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by triceratop » Fri Apr 14, 2017 3:12 pm

The point about 1099-R coding can be understood better by looking at the section "Guide to Distribution Codes" in Instructions for Form 1099-R (note: taxpayers do not file this; but it is instructions for those who do). Note that there are special codes for excess contributions, so it is not correct to conclude that what you deem a qualified distribution is the same as removing the excess contribution for 2016.

edit: I also want to clarify about one of Spirit Rider's suggested alternatives

Spirit Rider wrote:There are three options to avoid paying taxes on the earnings of 2016 excess Roth IRA contributions:

Remove the excess contributions and associated earnings by the tax filing deadline (4/18/17) including extensions (10/16/17).

<snip>


From 2016 Instructions for Form 8606 (Return of IRA contributions):

If, in 2016, you made traditional IRA contributions or Roth IRA contributions for 2016 and you had those contributions returned to you with any related earnings (or minus any loss) by the due date (including extensions) of your 2016 tax return, the returned contributions are treated as if they were never contributed. Don’t report the contribution or distribution on Form 8606 or take a deduction for the contribution. However, you must include the amount of the distribution of the returned contributions you made in 2016 and any related earnings on your 2016 Form 1040, line 15a; Form 1040A, line 11a; or Form 1040NR, line 16a. Also include the related earnings on your 2016 Form 1040, line 15b; Form 1040A, line 11b; or Form 1040NR, line 16b. Attach a statement explaining the distribution. You can’t deduct any loss that occurred (see Pub. 590-B for an exception if you withdrew the entire amount in all your traditional or Roth IRAs). Also, if you were under age 59½ at the time of a distribution with related earnings, you generally are subject to the additional 10% tax on early distributions (see Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts).


OP must pay tax on earnings if withdrawn in a timely fashion to undo the 2016 contribution.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 3:50 pm

triceratop wrote:The point about 1099-R coding can be understood better by looking at the section "Guide to Distribution Codes" in Instructions for Form 1099-R (note: taxpayers do not file this; but it is instructions for those who do).

Yes, this is important. Maybe more emphasis in this thread should have been put on the 1099-R coding that the IRS will receive. Pages 15-17 show all the possible codes and "8" and "P" are for Excess Contributions being removed. Once you enter this into your software, Form 5329 should be filled out for you. (I tried it in my tax software.)

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 4:13 pm

You are still not getting this. You are overthinking it.

After 12/31/16, it was a 2016 excess Roth IRA contribution. You have three options:
  1. It never happened. Recharacterise it as a non-deductible traditional IRA contribution.
  2. Fix it. Remove the excess contribution and earnings by the tax filing deadline (04/18/17) including extensions (10/16/17).
  3. Pay for it. Complete Form 5329, calculating a 6% excise tax, transferring that liability to your Form 1040
If you choose to pay the excise tax, the earnings on the excess contribution do not ever come out. In fact, you are paying the excise tax for that privilege.

Then you will have a carry-forward balance of that excess contribution and you will owe a 6% excise tax on any carry-forward balance forever, unless:
  1. You have unused Roth IRA contribution space to enter on Form 5329 Line 19 >= line 18.
  2. You make a qualified distribution to enter on Line 20 >= Line 18.
  3. A combination of the above >= Line 18
  4. All Roth IRA balances are <= Line 18 and you distribute the entire balance
It is very simple, straightforward and clearly set out on Form 5329 and in the Instructions. I really don't know what more I can say. Please study Form 5329 and the Instructions.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by triceratop » Fri Apr 14, 2017 5:04 pm

I just want to reiterate, with regards to point (2) below, as I said above you still pay tax on the earnings if OP chooses to opt for FIxing it.

Spirit Rider wrote:You are still not getting this. You are overthinking it.

After 12/31/16, it was a 2016 excess Roth IRA contribution. You have three options:
  1. It never happened. Recharacterise it as a non-deductible traditional IRA contribution.
  2. Fix it. Remove the excess contribution and earnings by the tax filing deadline (04/18/17) including extensions (10/16/17).
  3. Pay for it. Complete Form 5329, calculating a 6% excise tax, transferring that liability to your Form 1040
If you choose to pay the excise tax, the earnings on the excess contribution do not ever come out. In fact, you are paying the excise tax for that privilege.

Then you will have a carry-forward balance of that excess contribution and you will owe a 6% excise tax on any carry-forward balance forever, unless:
  1. You have unused Roth IRA contribution space to enter on Form 5329 Line 19 >= line 18.
  2. You make a qualified distribution to enter on Line 20 >= Line 18.
  3. A combination of the above >= Line 18
  4. All Roth IRA balances are <= Line 18 and you distribute the entire balance
It is very simple, straightforward and clearly set out on Form 5329 and in the Instructions. I really don't know what more I can say. Please study Form 5329 and the Instructions.


(emphasis mine on point (B), as that is what is disputed)

Yes, and the objection celia and I are pointing out is that withdrawing the contribution is not considered a qualified distribution for the purposes of entering on line 20; the instructions for Form 8606 indicate that one generally enters the amount from Form 8606 Line 19. The reason one does not enter return of contributions on this line on Form 5329 can be found in the Form 8606 Line 19 instructions:

Don’t include on line 19 any of the following.

<snip>
Distributions that are a return of contributions under Return of IRA Contributions, earlier
<snip>


So it is not correct that the withdrawal of the excess contribution will count towards Line 20, and yet Alan S. said "Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings)." Not true!
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 6:27 pm

triceratop wrote:I just want to reiterate, with regards to point (2) below, as I said above you still pay tax on the earnings if OP chooses to opt for FIxing it.

And I said that in one of my earlier responses, and thus the reason for the excise tax/qualified distribution. The earnings are not taxable income in that case

You make a qualified distribution to enter on Line 20 >= Line 18.
(emphasis mine on point (B), as that is what is disputed)

Yes, and the objection celia and I are pointing out is that withdrawing the contribution is not considered a qualified distribution for the purposes of entering on line 20; the instructions for Form 8606 indicate that one generally enters the amount from Form 8606 Line 19. The reason one does not enter return of contributions on this line on Form 5329 can be found in the Form 8606 Line 19 instructions:

Don’t include on line 19 any of the following.

<snip>
Distributions that are a return of contributions under Return of IRA Contributions, earlier
<snip>

So it is not correct that the withdrawal of the excess contribution will count towards Line 20, and yet Alan S. said "Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings)." Not true!

And the reason is that you and celia are still not getting it. A qualified distribution is not a return of contribution

I repeat again, Form 5329 Instructions for line 20: Generally, enter the amount from Form 8606, line 19, plus any qualified distributions.

We are not talking about Form 8606 Line 19, we are talking about qualified distributions. And yes let's talk about the 1099-R coding. This will most definitely not be coded as an excess contribution "J 8" (it is 2017), the code for a qualified distribution will depend on the OP's circumstances.

The thing the two of you don't seem to grasp, is that a qualified distribution of a Roth IRA contribution is not a return of contribution.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by triceratop » Fri Apr 14, 2017 6:31 pm

Alan S didn't say to make a qualified distribution. He said to remove the contribution, leave the earnings. That is a return of contribution, unless words have no meaning.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by LadyGeek » Fri Apr 14, 2017 7:04 pm

We have two on-going discussions -

1. mask107 needs help and is confused on what to do.

mask107, Do you need a summary of what to do, or, are you stuck in one particular spot? Don't give up. If the answers are confusing, please let us know and we'll try again.

There are 3 distinct areas which have a very specific meaning to the IRS and are defined in the IRS publications. It's important to recognize the differences.

- Contributions
- Excess contributions
- Distributions

Your best course (other than paying for professional advice, which is always a smart option) is to read the IRS guidelines and outline a plan on how to approach this. While the members in this forum are very experienced, there may be an occasion where someone makes a statement that has been inadvertently misstated or misinterpreted.* There is a misunderstanding which resulted in the second discussion.

2. An on-going discrepancy with Alan S.'s statement. I underlined the point of contention:
Alan S. wrote:
Tanelorn wrote:
mask107 wrote:I am considering a career change so I will not be working in 2017. What are my options then? I can just withdraw 5500 as a regular distribution without the earnings (the excess) in 2017 and be fine right? I just don't want to pay 30% tax for 2016 on the withdrawal

if you want to stop the penalties, you eventually have to either take out the excess contributions and their associated earnings (and pay tax on the earnings when you do), or you have to earn enough income to have the right to make the contribution. If you think your tax bracket is very high for 2016 and will be much lower in 2017, that's another reason to consider paying the 6% excess contribution to delay taking out your taxable excess associated earnings until 2017.


Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings). This can be done anytime in 2017 as long as the request does not refer to a return of the 2016 contribution. Do not even mention an excess contribution or a 2016 contribution to the custodian, just ask for a distribution of 5500 flat. That will result in a 1099R that is not coded as a return of any specific contribution. But it is safer to wait until after 10/15 since after that date there is no risk of the custodian misinterpreting the request and do the earnings calc. This also allows more time for the contribution to generate tax free earnings.

When this is done, the only tax due with be the 2016 6% excise tax. The gains remain in the Roth, so they do NOT have to be taken out at any time. Conversely, if the contribution is returned with earnings, the earnings must be taxable in the year the contribution was made. If the earnings were 40% of the contribution, it would probably be wise to pay the excise tax for one year even if your tax rate was 0 for the year of the contribution since you are banking 2200 of tax free earnings for $330. That equates to a conversion at a rate of 15% which is usually a winner.

Alan S. - Please clarify how this statement complies with IRS guidelines. Or, was anything said in error?

* We expect members to provide guidance in compliance with US law (the IRS falls under Title 26 of USC). See: Hierarchy of tax authority. Not doing so takes the discussion down a different path.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 7:16 pm

LadyGeek wrote:We have two on-going discussions -

1. mask107 needs help and is confused on what to do.

mask107, Do you need a summary of what to do, or, are you stuck in one particular spot? Don't give up. If the answers are confusing, please let us know and we'll try again.

There are 3 distinct areas which have a very specific meaning to the IRS and are defined in the IRS publications. It's important to recognize the differences.

- Contributions
- Excess contributions
- Distributions

Your best course (other than paying for professional advice, which is always a smart option) is to read the IRS guidelines and outline a plan on how to approach this. While the members in this forum are very experienced, there may be an occasion where someone makes a statement that has been inadvertently misstated or misinterpreted.* There is a misunderstanding which resulted in the second discussion.

2. An on-going discrepancy with Alan S.'s statement. I underlined the point of contention:
Alan S. wrote:
Tanelorn wrote:
mask107 wrote:I am considering a career change so I will not be working in 2017. What are my options then? I can just withdraw 5500 as a regular distribution without the earnings (the excess) in 2017 and be fine right? I just don't want to pay 30% tax for 2016 on the withdrawal

if you want to stop the penalties, you eventually have to either take out the excess contributions and their associated earnings (and pay tax on the earnings when you do), or you have to earn enough income to have the right to make the contribution. If you think your tax bracket is very high for 2016 and will be much lower in 2017, that's another reason to consider paying the 6% excess contribution to delay taking out your taxable excess associated earnings until 2017.


Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings). This can be done anytime in 2017 as long as the request does not refer to a return of the 2016 contribution. Do not even mention an excess contribution or a 2016 contribution to the custodian, just ask for a distribution of 5500 flat. That will result in a 1099R that is not coded as a return of any specific contribution. But it is safer to wait until after 10/15 since after that date there is no risk of the custodian misinterpreting the request and do the earnings calc. This also allows more time for the contribution to generate tax free earnings.

When this is done, the only tax due with be the 2016 6% excise tax. The gains remain in the Roth, so they do NOT have to be taken out at any time. Conversely, if the contribution is returned with earnings, the earnings must be taxable in the year the contribution was made. If the earnings were 40% of the contribution, it would probably be wise to pay the excise tax for one year even if your tax rate was 0 for the year of the contribution since you are banking 2200 of tax free earnings for $330. That equates to a conversion at a rate of 15% which is usually a winner.

Alan S. - Please clarify how this statement complies with IRS guidelines. Or, was anything said in error?

* We expect members to provide guidance in compliance with US law (the IRS falls under Title 26 of USC). See: Hierarchy of tax authority. Not doing so takes the discussion down a different path.


I am more confused than ever sadly. Please read everything listed under as I believe it is all crucial to understand my current situation. Thanks

Here's a summary of my question:

Made over magi of earned income for 2016. Tax bracket is 30%. Not allowed to contribute to Roth IRA. Excess contributed $5500. Have one other regular IRA open at another brokerage but with only $80 in it after significant losses. Total contribution for all IRAs in 2016 is $5500, all of which is in Roth. Made about $15k in earnings since deposit and if I withdraw now, about $2k calculated earnings after formula of calculating earnings on excess. Also, not sure about whether I can still withdraw excess since brokerage may not complete withdrawal before deadline? Is it when the order was requested to brokerage or when it is completed to avoid penalty?

I will be going back to school in 2017 so will not have any earned income at all for 2017 and should be at lower tax bracket than 2016. Might also have capital loss of $40k in 2017 as well due to bad investments.

What would be the most cost effective way of proceeding to pay the least amount in penalties and taxes since it is still before tax deadline or would it not matter at all since I filed my taxes already? Would also note that I made a mistake and filed taxes already last week and marked a roth IRA contribution of 0 when I put in $5500 so was wondering whether removing excess contribution before deadline would be better for me in less penalties or should I just wait after deadline and find an amendment to this error or extension if possible? Still very new to taxes. Many thanks to all.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 8:04 pm

Let's start with some more clarification. Mask107, Are we to assume:

1. You already had about $40,000 in your Roth before you made the contribution and that it was a combination of contributions and earnings. Further, the account is currently worth $50,000 with the Excess Contribution and further gains.

2. You have a traditional IRA but currently it contains only $80 or $80,000.

3. When you filed your taxes, please clarify what you mean by reporting a Roth contribution of 0. It doesn't make sense that someone who is not contributing to a Roth would even be answering a question about Roth. What question(s) were you answering about Roth?

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 8:09 pm

IRS Forms and Instructions are considered a definitive word. I made specific reference cites to Form 5329 and Instructions. They are not in dispute with the actual IRC, just show the exact mechanics of performing the IRC. THis is usually far easier to decipher than CongressSpeak. No Publications were referenced.

26 U.S. Code § 4973 - Tax on excess contributions to certain tax-favored accounts and annuities—
(f) Excess contributions to Roth IRAsFor purposes of this section, in the case of contributions to a Roth IRA (within the meaning of section 408A(b)), the term “excess contributions” means the sum of—
  1. the excess (if any) of—
    1. the amount contributed for the taxable year to Roth IRAs (other than a qualified rollover contribution described in section 408A(e)), over
    2. the amount allowable as a contribution under sections 408A(c)(2) and (c)(3), and
  2. the amount determined under this subsection for the preceding taxable year, reduced by the sum of—
    1. the distributions out of the accounts for the taxable year, and
    2. the excess (if any) of the maximum amount allowable as a contribution under sections 408A(c)(2) and (c)(3) for the taxable year over the amount contributed by the individual to all individual retirement plans for the taxable year.
    For purposes of this subsection, any contribution which is distributed from a Roth IRA in a distribution described in section 408(d)(4) shall be treated as an amount not contributed.
Alan's statement is not at all inconsistant with 4973(f)(2)(A) above

"Assuming that applying the excess to 2017 is doubtful, the solution is just to remove the contribution (not earnings). This can be done anytime in 2017 as long as the request does not refer to a return of the 2016 contribution. Do not even mention an excess contribution or a 2016 contribution to the custodian, just ask for a distribution of 5500 flat. That will result in a 1099R that is not coded as a return of any specific contribution.

If it is not a return of excess contribution is is a distribution. As Alan and I stated, this will not be coded as a return of an excess contribution

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by mask107 » Fri Apr 14, 2017 8:26 pm

celia wrote:Let's start with some more clarification. Mask107, Are we to assume:

1. You already had about $40,000 in your Roth before you made the contribution and that it was a combination of contributions and earnings. Further, the account is currently worth $50,000 with the Excess Contribution and further gains.

Account had 30k prior. After contribution, $35500, rounded down to $35k to make it simplier for calculations. Now is $50000

2. You have a traditional IRA but currently it contains only $80 or $80,000.
Traditional is only $80.

3. When you filed your taxes, please clarify what you mean by reporting a Roth contribution of 0. It doesn't make sense that someone who is not contributing to a Roth would even be answering a question about Roth. What question(s) were you answering about Roth?

Like I said, I made an error and reported $0 when I placed $5500 in actually. This is what I meant by filing an amendment. Was wondering whether I should file amendment before deadline since tax was already filed.


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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by Spirit Rider » Fri Apr 14, 2017 9:22 pm

mask107 wrote:
celia wrote:3. When you filed your taxes, please clarify what you mean by reporting a Roth contribution of 0. It doesn't make sense that someone who is not contributing to a Roth would even be answering a question about Roth. What question(s) were you answering about Roth?

Like I said, I made an error and reported $0 when I placed $5500 in actually. This is what I meant by filing an amendment. Was wondering whether I should file amendment before deadline since tax was already filed.

celia: Tax software always has you enter the Roth IRA contribution amount to determine if you have an excess contribution or are eligible for the Saver's Credit.

mask107: The entry is for the above purposes. The actual Roth IRA contribution is not actually reported on your return.

Regardless of the corrective action you take, you will have to file an amended return and in both cases, you will have until 10/16 to do this.

1. If you choose to leave the excess contribution in the Roth IRA, you will have to file a 2016 1040X amended return with a Form 5329 by 10/16/2017. This will report the excess contribution and calculate the 6% excise tax ($5,500) * 0.06 = $330. The will be entered on the Form 1040X. Your tax software should be able to generate the 1040X and 5329. If you do not have earned income in 2017, you will have to take a qualified distribution of only the $5,500 contribution amount before 12/31/17. The Roth IRA custodian will report this distribution on a 1099-R by 1/31/2018. You will file a 2017 Form 5329 reporting this tax-free distribution with your 2017 (excise tax free) tax return.

2. If you chose to remove the excess contribution and earnings. You will have to remove the excess contribution and earnings by 10/16/17. You do not report the return of the excess contribution. It will be reported by the Roth IRA custodian by 1/31/2018 as a 2017 return of excess contribution. The earnings on the excess contribution will be reported on a 2016 1040X amended return. It is sometimes hard to know what the exact earnings will be. Given your descriptions, it is probably safe to say that this will increase your 2016 AGI and taxable income by $2,000 - $2,500. Your tax liability will increase by that amount times your marginal tax rate. Your Form 1040X amended return will reflect that.

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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by LadyGeek » Fri Apr 14, 2017 9:45 pm

Spirit Rider wrote:IRS Forms and Instructions are considered a definitive word. I made specific reference cites to Form 5329 and Instructions. They are not in dispute with the actual IRC, just show the exact mechanics of performing the IRC. THis is usually far easier to decipher than CongressSpeak. No Publications were referenced.

26 U.S. Code § 4973 - Tax on excess contributions to certain tax-favored accounts and annuities—

US Law, which you've quoted, is the definitive word. IRS Forms and Instructions are the interpretations of the law. The gory details are explained in the wiki: Hierarchy of tax authority

You've made your point. Let's hold-off on further interpretations until Alan S. chimes in to clarify what he meant.

Spirit Rider wrote:1. If you choose to leave the excess contribution in the Roth IRA, you will have to file a 2016 1040X amended return with a Form 5329 by 10/16/2017. This will report the excess contribution and calculate the 6% excise tax ($5,500) * 0.06 = $330. The will be entered on the Form 1040X. Your tax software should be able to generate the 1040X and 5329. If you do not have earned income in 2017, you will have to take a qualified distribution of only the $5,500 contribution amount before 12/31/17. The Roth IRA custodian will report this distribution on a 1099-R by 1/31/2018. You will file a 2017 Form 5329 reporting this tax-free distribution with your 2017 (excise tax free) tax return.

mask107 - TaxAct has some guidance: IRA or Roth IRA - Excess Contributions, you may find this easier to read. Note that the term "excise tax" is correct.

Also try looking through the TaxAct help for relevant topics. The IRS publications and forms are correct, but not intended as tutorials. Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts

Why TaxAct? I use it. Try searching TurboTax if you want to go that route. My point is that the tax programs want you to use their software, so they go to a lot of effort to make this stuff easy to read. You'll also get help on how to do a 1040-X. I've done one before, just follow the tax software instructions.
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Re: Should I take 6% penalty for excess Roth IRA contribution since I had significant earnings?

Post by celia » Fri Apr 14, 2017 9:46 pm

Mask, I will respond in a few hours and am in contact with Alan. We will try to show you your options and the associated "cost" of each choice. Will be back..
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