Ineligibile Roth Contributions

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vaught
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Ineligibile Roth Contributions

Post by vaught » Tue Feb 06, 2018 11:29 am

Hypothetical scenario:

What is the effect of contributing directly to a Roth IRA if you are ineligible because you file taxes as MFS or any other reason?

The Wizard
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Re: Ineligibile Roth Contributions

Post by The Wizard » Tue Feb 06, 2018 11:45 am

You have to pay an annual 6% penalty on the disallowed contributions...
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Rupert
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Re: Ineligibile Roth Contributions

Post by Rupert » Tue Feb 06, 2018 11:49 am

You keep paying that 6% annual penalty until you fix the error. The best way to fix the error is to move the ineligible contribution to a tIRA before your tax deadline. The next best way to fix it is to withdraw the funds and invest them elsewhere before your tax deadline.

vaught
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Re: Ineligibile Roth Contributions

Post by vaught » Tue Feb 06, 2018 12:00 pm

Rupert wrote:
Tue Feb 06, 2018 11:49 am
You keep paying that 6% annual penalty until you fix the error. The best way to fix the error is to move the ineligible contribution to a tIRA before your tax deadline. The next best way to fix it is to withdraw the funds and invest them elsewhere before your tax deadline.
Thanks. Unfortunately this friend has been doing this for 3-4 years. Is it odd that IRS hasn't said anything after filing their taxes in previous years?

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njboater74
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Re: Ineligibile Roth Contributions

Post by njboater74 » Tue Feb 06, 2018 12:11 pm

Yes, the IRS often doesn't pick this up right away, but there's a decent chance they will eventually. Has your friend even been declaring his Roth IRA contributions with their returns?

It's not a big deal. Have you friend withdraw the excess contributions immediately, then file form 5329 for each year that the excess funds were in the accounts.
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The Wizard
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Re: Ineligibile Roth Contributions

Post by The Wizard » Tue Feb 06, 2018 12:28 pm

The IRS finds it quite difficult to monitor taxpayer cash flows in a timely fashion, even when forms are submitted properly.

And places like vanguard.com aren't helping much either as regards ineligible Roth IRA contributions.
When I log on, their website continues to prompt me to contribute $6500 for this year and last, though I no longer have any earned income...
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Rupert
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Re: Ineligibile Roth Contributions

Post by Rupert » Tue Feb 06, 2018 12:32 pm

The Wizard wrote:
Tue Feb 06, 2018 12:28 pm
The IRS finds it quite difficult to monitor taxpayer cash flows in a timely fashion, even when forms are submitted properly.

And places like vanguard.com aren't helping much either as regards ineligible Roth IRA contributions.
When I log on, their website continues to prompt me to contribute $6500 for this year and last, though I no longer have any earned income...
Yes, this annoys me too. Vanguard does not even include a disclaimer on the contribution page to the effect that your personal contribution limit may differ from the maximum contribution limit.

vaught
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Re: Ineligibile Roth Contributions

Post by vaught » Tue Feb 06, 2018 12:34 pm

The Wizard wrote:
Tue Feb 06, 2018 12:28 pm
The IRS finds it quite difficult to monitor taxpayer cash flows in a timely fashion, even when forms are submitted properly.

And places like vanguard.com aren't helping much either as regards ineligible Roth IRA contributions.
When I log on, their website continues to prompt me to contribute $6500 for this year and last, though I no longer have any earned income...
Gotcha. So the end result is friend is left with the decision to (1) do nothing (and risk penalties down the road) or (2) pay $330 (5,500 x 6%) for every year they made an ineligible contribution. And I assume there may be interest or some other penalty on the $330 payment that would have been owed 3-4 years ago?

Alan S.
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Re: Ineligibile Roth Contributions

Post by Alan S. » Tue Feb 06, 2018 12:59 pm

Yes, the IRS may or may not bill late interest charges for late payment of the excise tax.

Form 5329 manages the outstanding amount of excess contributions. If it is completed correctly, it will result in the excess amount being applied to a later year for which the taxpayer is eligible for contributions, but did not contribute. It will also apply a non corrective distribution taken in any year after the contribution year to reduce the excess amount starting in the year of the distribution.

Therefore, if the 5329 forms are completed carefully, they will automatically reduce the outstanding excess as much as possible.

Note that for 2017 contributions, the contribution can still be returned with allocated earnings and there will be no excise tax on the 2017 excess. However, for prior year excess amounts still in the Roth at the end of 2017, the excise tax will be due on Form 5329 for 2017.

Spirit Rider
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Re: Ineligibile Roth Contributions

Post by Spirit Rider » Tue Feb 06, 2018 1:11 pm

vaught wrote:
Tue Feb 06, 2018 12:34 pm
Gotcha. So the end result is friend is left with the decision to (1) do nothing (and risk penalties down the road) or (2) pay $330 (5,500 x 6%) for every year they made an ineligible contribution. And I assume there may be interest or some other penalty on the $330 payment that would have been owed 3-4 years ago?
The excise tax is based on the total accumulated excess contribution balance on 12/31 of each year. For example:

If your friend made a $5,500 excess Roth IRA contribution in 2014, 2015, 2016, and 2017 and made no distributions:
  • 12/31/2014 balance Form 5329 = $5,500 * 6% = $330.
  • 12/31/2015 balance Form 5329 = $5,500 + $5,500 = $11,000 * 6% = $660.
  • 12/31/2016 balance Form 5329 = $11,000 + $5,500 = $$16,500 * 6% = $990.
  • 2017 Remove the excess contribution before filing the tax return up until the tax filing deadline (04/17/18) including extensions (10/15/18).
  • 12/31/2017 balance Form 5329 = $16,500 + $0 = $$16,500 * 6% = $990.
  • Prior to 12/31/18 distribute $16,500 from Roth IRA.
  • 12/31/2018 balance Form 5329 = $16,500 - $16,500 = $0 * 6% = $0.
So the total excise tax due will be $330 + $660 + $990 + $990 = $2,970. The IRS will bill for any interest penalties after the filing of the Form 5329s and payment of the excise tax.

Note: It is very important for your friend to deal with this now. Even if they remove the 2017 excess contribution and earnings and distribute the prior excess balance, there will be interest penalties applying every year.

Most importantly there is no Statute Of Limitations (SOL) on failure to file Form 5329 and pay the excise taxes.!!!

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