Excess Contributions to Roth IRA

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johnnylawrwb
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Joined: Mon Jun 19, 2017 1:30 pm

Excess Contributions to Roth IRA

Post by johnnylawrwb » Mon Jun 19, 2017 1:53 pm

I have spent the last two hours reading every thread I can find on here (Alan S. is a sage), and just want to completely nail down what I've compiled. I'm helping a friend with an issue revolving around contributing to a Roth-IRA for the past few years while making too much money.

Regarding the 2016 contribution, I was going to have this re-characterized as non-deductible. I believe at that point they'd pay taxes on earnings and that's it, as long as they're re-characterized before 10/17.

The treatment for the past years is where I get hung up. I know there's no way to re-characterize, and (I think) obviously it's not rollover eligible, so I believe I'd need to withdraw the entire amount. My friend has been paying the 6% excise yearly. When we distribute it, do I need to worry about 10% excise taxes & income taxes? I've read conflicting information on this and am just not 100% comfortable with a resolution. I believe they'd need to pay 10%+taxes on the earnings as they're under 59.5, but I'm honestly not sure. I believe the basis would come out clean, with no penalties or taxes.

I also believe an 8606 will need to be filed at some point to report the basis.

Thanks in advance for your help.

Alan S.
Posts: 6855
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Excess Contributions to Roth IRA

Post by Alan S. » Mon Jun 19, 2017 4:14 pm

For all the pre 2016 excess Roth contributions, there are 3 ways to eliminate the 6% excise tax:

1) Do NOT make a Roth contribution in a year you are eligible, so that some of the excess can be applied to that eligible year. This is done on Form 5329, which needs to be filed in any case when an excess contribution balance exists.
2) Take a Roth distribution. Distributions taken in any year reduce the excess contribution balance except for excess contributions made for that same year. This is also reported on a 5329 as above.
3) Assuming that the above two cases do not apply, then take a distribution of the remaining excess balance before this year ends. Because the excess tax is due for all these prior year excess contributions, only the excess amount is withdrawn, no earnings are withdrawn. The actual distribution should be tax free since it is a return of regular Roth contributions. This distribution is reported on Form 8606 and also on a 5329. The 5329 shows the excess contribution balance has been eliminated and no excise tax is due for the year of this distribution.

Since the prior excise taxes have been paid, I assume the 5329 for those years is correct, so only item 3) above needs to be done now. For 2016, a 5329 had to be filed to pay the excise tax on pre 2016 contributions that were still in the account on 12/31/2016. The 2016 year excess should not be reported on that Form because it will be removed separately before October with any earnings. Those earnings will be taxable and subject to penalty for the year the contribution was made, probably 2016. These earnings should be the only amount subject to ordinary tax and penalty. All the rest is excise tax at 6% and most of that has already been paid.

Finally, if the 2016 excess Roth contribution is recharacterized no later than October 15th as a non deductible TIRA contribution, it can then be converted to a Roth IRA right away. Tax would only be due on the earnings when converted, no penalty. This assumes there is no other non Roth IRA balance that would cause the taxable amount of the conversion to be much higher. If there is another pre tax TIRA balance, then other options such as simple removal of the 2016 excess plus earnings should be considered.

johnnylawrwb
Posts: 3
Joined: Mon Jun 19, 2017 1:30 pm

Re: Excess Contributions to Roth IRA

Post by johnnylawrwb » Tue Jun 20, 2017 8:55 am

Thanks for your help Alan.

So to be clear, if we do end up withdrawing earnings from prior years, I'd pay 10% penalty + taxes, correct? I don't think she wants to maintain the extra account. She doesn't expect to ever be able to contribute to it (in the foreseeable future), so she's going the route of a non-deductible IRA.

Also, pardon my ignorance, but does anything change if she goes non-deductible IRA versus TIFA? She does not have another account elsewhere, so anything converted would be fresh.

Alan S.
Posts: 6855
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Excess Contributions to Roth IRA

Post by Alan S. » Tue Jun 20, 2017 11:20 am

What amount will be left in the Roth IRA after all the excess contributions (plus earnings on the 2016 contribution only) have been withdrawn? There could be past allowable contributions that were not excess, possibly conversions, and earnings.

Any conversion money withdrawn under 5 years would incur a 10% penalty assuming no penalty exception, and any earnings withdrawn would be subject to both tax and penalty as you expected unless she qualifies for one of the penalty exceptions.

Generally, unless the earnings amount is too small to bother with, she should not withdraw the earnings except for a true emergency, especially if she is anywhere near 59.5.

Note that the 5 year holding period cannot start with an excess contribution, so if she made no allowable contributions and no conversions, then her 5 year holding period has not even started.

If she wants to do back door Roths in the future and because she has no other non Roth IRA accounts, she can convert into the current Roth and avoid maintaining an extra Roth account. If these conversions are tax free or nearly tax free she will not be recharacterizing them so there is no need for her to convert into an empty Roth account every time.

johnnylawrwb
Posts: 3
Joined: Mon Jun 19, 2017 1:30 pm

Re: Excess Contributions to Roth IRA

Post by johnnylawrwb » Wed Jun 21, 2017 12:08 pm

Thanks a ton for your help, Alan. The clarity of your information is much appreciated.

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