What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

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S17C
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What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 12:18 pm

Curious about this scenario:

A person makes the full year's $5,500 IRA contribution on January 2nd in a personal brokerage account and invests it all immediately. On January 3rd the person gets terminated and is unemployed rest of the year (say only $500 total earned income).

What is the tax consequence of the $5000 over contribution into the IRA account?
Last edited by S17C on Fri Jun 16, 2017 12:21 pm, edited 1 time in total.

fishmonger
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by fishmonger » Fri Jun 16, 2017 12:20 pm

Are you married? If so, you can use your SOs income to qualify

Topic Author
S17C
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 12:21 pm

Hypothetical. Say the person is single.

DSInvestor
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by DSInvestor » Fri Jun 16, 2017 12:22 pm

If the person ends the year with only $500 in compensation, there is an excess contribution of $5000. Here's a link to Fairmark.com page on Excess contribution to Roth IRA:
http://fairmark.com/retirement/roth-acc ... roth-iras/
Wiki

ianferrel
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by ianferrel » Fri Jun 16, 2017 12:24 pm

Two options:

1. Withdraw the excess (and any earnings on it) before filing taxes. You then pay taxes on whatever the earnings were (probably at short term cap gains rate).
2. Pay 6% a year penalties forever on the excess.

(you should probably choose #1)

Topic Author
S17C
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 12:30 pm

Sounds like there would be an early withdrawal penalty (10%?) to remove the $5000 from the IRA if under age 59.5. So that amounts to about a $500 minimum tax consequence.

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EATaxGuy
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by EATaxGuy » Fri Jun 16, 2017 12:35 pm

S17C wrote:Sounds like there would be an early withdrawal penalty (10%?) to remove the $5000 from the IRA if under age 59.5. So that's a $500 tax consequence for the hasty contribution on January 2nd.
There is no 10% penalty for timely removing the excess. "Timely" being before you file next year's tax return.
[Edit] IRC Section 402(m)(7)(A) indicates no time limit for dodging the 10% penalty for removing the excess. [/Edit]
You may have been handed a cactus, but sitting on it is up to you.

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S17C
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 12:52 pm

Here's the tax penalty information found in the Fairmark link posted above:
Withdrawing excess by due date of return. 
If you find that your contribution to a Roth IRA was improper or too large, you can avoid the 6% penalty tax by taking the money out. Relief from the penalty is available only if the following are true:

You receive a distribution from the IRA on or before the due date (including extensions) for filing your return for the year of the contribution.
The distribution includes the amount of the excess contribution and the amount of net income attributable to the excess.

When you choose this method of correction, you’re required to report and pay tax on the net income attributable to the excess in the year of the contribution, even if you take it out during the following year, before the return due date. The earnings will be taxed like any other taxable distribution of earnings from a Roth IRA, and will be subject to the early distribution penalty if you’re under 59½ unless an exception applies.

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Pranav
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by Pranav » Fri Jun 16, 2017 1:11 pm

What if the contribution was to the Traditional IRA?
https://www.bogleheads.org/wiki

deltaneutral83
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by deltaneutral83 » Fri Jun 16, 2017 1:21 pm

Is the "earned income" amount after deductions (AGI) or before? Basically, if your employer has shelled out $5,500 to you, are you good to go regardless of deductions?

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S17C
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 1:36 pm

Assume $500 pre-tax income for full year but had contributed $5,500.

TropikThunder
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by TropikThunder » Fri Jun 16, 2017 1:59 pm

Pranav wrote:What if the contribution was to the Traditional IRA?
The income requirements are the same for Traditional and Roth IRA's, i.e., you cannot contribute more than your taxable earnings for the year. The difference will be in how the removed excess is taxed (Roth IRA contribution was already taxed but the Traditional contribution was not). In either case, the earnings are taxed as ordinary income (plus the 10% penalty if you're <59.5).
S17C wrote:Sounds like there would be an early withdrawal penalty (10%?) to remove the $5000 from the IRA if under age 59.5. So that amounts to about a $500 minimum tax consequence.
The early withdrawal penalty applies to the earnings, not to the contribution. Roth contributions can be removed at any time without penalty, which is why some people consider their Roth as part of their emergency fund. [Note: "qualified distributions" in the below quote refers to rules applied to earnings, not to the original contributions]
You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s).
https://www.irs.gov/publications/p590b/ ... 1000231057

Here's a Vanguard link that's easier to read then the IRS policy.
https://investor.vanguard.com/ira/exces ... on?lang=en

Spirit Rider
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by Spirit Rider » Fri Jun 16, 2017 2:45 pm

ianferrel wrote:Two options:

1. Withdraw the excess (and any earnings on it) before filing taxes. You then pay taxes on whatever the earnings were (probably at short term cap gains rate).
2. Pay 6% a year penalties forever on the excess.

(you should probably choose #1)
A couple of corrections.

1. There is no such thing as short or long term capital gains in an IRA. Earnings due to excess contributions are always taxed as ordinary income.

2. You can avoid paying the excise tax in the subsequent year(s) by applying future IRA contribution space to the excess. Also, with a Roth IRA you can just remove the excess contribution and pay no tax on it or any earnings.

TropikThunder
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by TropikThunder » Fri Jun 16, 2017 3:20 pm

Spirit Rider wrote: 2. You can avoid paying the excise tax in the subsequent year(s) by applying future IRA contribution space to the excess. Also, with a Roth IRA you can just remove the excess contribution and pay no tax on it or any earnings.
The earnings do get taxed and penalized if <59.5 (see the Vanguard and IRS links in my earlier post).
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.

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S17C
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Re: What if current year's IRA maxed on Jan 2nd but lose job next day & unemployed rest of year?

Post by S17C » Fri Jun 16, 2017 3:46 pm

Thanks for the information!

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