Potential excess ROTH

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Topic Author
samsdad
Posts: 723
Joined: Sat Jan 02, 2016 6:20 pm

Potential excess ROTH

Post by samsdad » Wed Sep 11, 2019 11:37 am

I need advice on what to do. I've been contributing to my newly opened (2019) Roth throughout the year thinking that DW and I were going to be under the income phaseout/cutoff. Turns out we might be over, if my small business gets a big order in the next few months (looks increasingly likely).

To make matters worse, I converted 10,453.52 from my tIRA to my Roth earlier this year (that's how confident I was that we were going to be well under the phaseout/cutoff).

Given the above, I've stopped all contributions to my Roth pending what comes up in my business.

Let's assume I go over the income limit (great problem to have I suppose).
To avoid the excess contributions tax:

withdraw the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
withdraw any income earned on the excess contribution.
See Pub 590-A for certain conditions that may allow you to avoid including withdrawals of excess contributions in your gross income.
https://www.irs.gov/retirement-plans/pl ... ion-limits

Questions:

1. I understand the above to mean that I can withdraw the contribution while avoiding a 6% tax penalty, but will have to pay 10% tax on the income earned on the excess contribution absent the usual conditions? Correct?

2. Getting back to that aforementioned 10k conversion. So, as I type this my total Roth amount is about 15k. I've contributed 2769.17 (strange amount due to Fidelity rewards points being deposited there). I have 2473.09 in gains as I type this. Some of those gains comes from that 10k that I converted, of course. So, how much of that is needs to be withdrawn to be taxed at that 10%?

3. Wading deeper into the waters, I understand that I can re-characterize the Roth contributions to a tIRA. Will this potentially solve my problem?

A recharacterization allows you to treat a regular contribution made to a Roth IRA or to a traditional IRA as having been made to the other type of IRA.

. . .

To recharacterize a regular IRA contribution, you tell the trustee of the financial institution holding your IRA to transfer the amount of the contribution plus earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a different type of IRA with the same trustee. If this is done by the due date for filing your tax return (including extensions), you can treat the contribution as made to the second IRA for that year (effectively ignoring the contribution to the first IRA).
https://www.irs.gov/retirement-plans/ir ... tributions (my emphasis)

To make matters interesting, I've already made 1347.69 in contributions to my tIRA this year. :D

FWIW, I'm not currently covered by a retirement plan at work; DW is, and is maxing out her 401k.

4. If I can or should re-characterize, I would obviously fall under the 6k limit with my prior 1347.69 straight contribution to my tIRA plus the 2769.17 that I've contributed to my Roth this year (4116.86). If I include the entirety of the 2473.09 in gains, I'll be over. So, again, how much of those gains are calculated as being part of the excess?

HELP!

Alan S.
Posts: 8565
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Potential excess ROTH

Post by Alan S. » Wed Sep 11, 2019 5:09 pm

samsdad wrote:
Wed Sep 11, 2019 11:37 am
I need advice on what to do. I've been contributing to my newly opened (2019) Roth throughout the year thinking that DW and I were going to be under the income phaseout/cutoff. Turns out we might be over, if my small business gets a big order in the next few months (looks increasingly likely).

To make matters worse, I converted 10,453.52 from my tIRA to my Roth earlier this year (that's how confident I was that we were going to be well under the phaseout/cutoff).

Given the above, I've stopped all contributions to my Roth pending what comes up in my business.

Let's assume I go over the income limit (great problem to have I suppose).
To avoid the excess contributions tax:

withdraw the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
withdraw any income earned on the excess contribution.
See Pub 590-A for certain conditions that may allow you to avoid including withdrawals of excess contributions in your gross income.
https://www.irs.gov/retirement-plans/pl ... ion-limits

Questions:

1. I understand the above to mean that I can withdraw the contribution while avoiding a 6% tax penalty, but will have to pay 10% tax on the income earned on the excess contribution absent the usual conditions? Correct?

A little worse. The allocated income on the returned contribution will be taxable at your marginal tax rate AND you will owe the 10% penalty on it unless you qualify for a penalty exception (usually being 59.5, but there are others).

2. Getting back to that aforementioned 10k conversion. So, as I type this my total Roth amount is about 15k. I've contributed 2769.17 (strange amount due to Fidelity rewards points being deposited there). I have 2473.09 in gains as I type this. Some of those gains comes from that 10k that I converted, of course. So, how much of that is needs to be withdrawn to be taxed at that 10%?

The net allocated income (NIA) formula basically takes the % gain (or loss) of the Roth IRA account balance during the period the regular contribution is in the Roth to determine the net earnings. There is no attempt to separate the gains on the conversion from the gains on the regular contribution. Your Roth custodian has software to calculate the gain (or net loss, if applicable) to determine the amount returned to you.



3. Wading deeper into the waters, I understand that I can re-characterize the Roth contributions to a tIRA. Will this potentially solve my problem?

A recharacterization allows you to treat a regular contribution made to a Roth IRA or to a traditional IRA as having been made to the other type of IRA.

. . .

To recharacterize a regular IRA contribution, you tell the trustee of the financial institution holding your IRA to transfer the amount of the contribution plus earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a different type of IRA with the same trustee. If this is done by the due date for filing your tax return (including extensions), you can treat the contribution as made to the second IRA for that year (effectively ignoring the contribution to the first IRA).
https://www.irs.gov/retirement-plans/ir ... tributions (my emphasis)

To make matters interesting, I've already made 1347.69 in contributions to my tIRA this year. :D

FWIW, I'm not currently covered by a retirement plan at work; DW is, and is maxing out her 401k.

The recharacterization formula to determine the amount transferred is the SAME as the above formula for return of the excess contribution. This amount is transferred to your TIRA and you are then treated as if you made a TIRA contribution all along. You are definitely eligible but may not be able to deduct the TIRA contribution. As it turns out, the modified AGI amount for whether YOU can deduct the contribution as a non participant in a workplace plan but filing jointly with a spouse who IS a participant is the SAME figure for determining if your Roth contribution is excess. So if your Roth contribution does turn out to be excess, you also will not be able to deduct any or perhaps only part of the TIRA contribution generated by recharacterization. Any non deductible portion must be reported on Form 8606, and your TIRA will now have basis. And it that is the case, you should investigate a back door Roth approach if and when you can transfer your pre tax TIRA balance into your workplace plan.

4. If I can or should re-characterize, I would obviously fall under the 6k limit with my prior 1347.69 straight contribution to my tIRA plus the 2769.17 that I've contributed to my Roth this year (4116.86). If I include the entirety of the 2473.09 in gains, I'll be over. So, again, how much of those gains are calculated as being part of the excess?

There are obviously several moving parts here, the main one being your modified AGI, but there are others such as the % of gain on your Roth contribution, and what the prospects are for you to eventually roll your pre tax TIRA balance into your employer plan. Does your employer offer a 401k or similar plan you can enroll in, and if they do does that plan accept rollovers from TIRA accounts. Once this info is known you can decide on how to proceed. There are other choices as well including paying the excise tax if your gains are large enough. This will keep the gains in the Roth if you withdraw just the contributions after 10/15, but you will owe the 6% excise tax. OR - if your modified AGI will drop in 2020, you can let the contribution stay in the Roth and apply it to 2020 on Form 5329.

So, there are actually 4 possible choices. Given that the year is almost 75% gone and your contributions will have to be dealt with in some manner, and because the deadlines to withdraw or recharacterize are over a year away, probably best to do nothing until your actual MAGI for 2019 is known around Feb or March, 2020. At that point you can figure the amount of gain or loss, you will know your permitted Roth contribution or deduction amount if your recharacterize, and will know your company retirement plan options. You also have until 4/15 to make additional IRA contributions for 2019.

HELP!

Topic Author
samsdad
Posts: 723
Joined: Sat Jan 02, 2016 6:20 pm

Re: Potential excess ROTH

Post by samsdad » Wed Sep 11, 2019 7:54 pm

Thank you very much Alan for taking your time to answer my questions. I truly appreciate your assistance. I have a couple of follow ups, if you wouldn't mind sharing a little more of your time.
Alan S. wrote:
Wed Sep 11, 2019 5:09 pm
...

There are obviously several moving parts here, the main one being your modified AGI, but there are others such as the % of gain on your Roth contribution, and what the prospects are for you to eventually roll your pre tax TIRA balance into your employer plan. Does your employer offer a 401k or similar plan you can enroll in, and if they do does that plan accept rollovers from TIRA accounts. Once this info is known you can decide on how to proceed.


I was thinking of opening a SIMPLE IRA at my business, but haven't done so yet (I actually recently posted about it oddly enough). I understand the deadline to do so is quickly approaching for this year. But a quick google search makes it looks like I can't roll over my pre-tax TIRA until two years have elapsed since the first participation? Correct?


There are other choices as well including paying the excise tax if your gains are large enough. This will keep the gains in the Roth if you withdraw just the contributions after 10/15, but you will owe the 6% excise tax.


What is this 10/15 deadline that you refer to? Did you mean 4/15?


OR - if your modified AGI will drop in 2020, you can let the contribution stay in the Roth and apply it to 2020 on Form 5329.


Unfortunately as a small-business owner, I think I'm going to have to accept that at least for our current situation, our MAGI is going to be unknowable (or close enough to the line to make a difference) until after each tax year passes. I used to just wait till tax time to see if I could contribute at all, but got ahead of myself this year (I think).



So, there are actually 4 possible choices. Given that the year is almost 75% gone and your contributions will have to be dealt with in some manner, and because the deadlines to withdraw or recharacterize are over a year away, probably best to do nothing until your actual MAGI for 2019 is known around Feb or March, 2020. At that point you can figure the amount of gain or loss, you will know your permitted Roth contribution or deduction amount if your recharacterize, and will know your company retirement plan options. You also have until 4/15 to make additional IRA contributions for 2019.

Alan S.
Posts: 8565
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Potential excess ROTH

Post by Alan S. » Wed Sep 11, 2019 11:19 pm

samsdad wrote:
Wed Sep 11, 2019 7:54 pm
Thank you very much Alan for taking your time to answer my questions. I truly appreciate your assistance. I have a couple of follow ups, if you wouldn't mind sharing a little more of your time.
Alan S. wrote:
Wed Sep 11, 2019 5:09 pm
...

There are obviously several moving parts here, the main one being your modified AGI, but there are others such as the % of gain on your Roth contribution, and what the prospects are for you to eventually roll your pre tax TIRA balance into your employer plan. Does your employer offer a 401k or similar plan you can enroll in, and if they do does that plan accept rollovers from TIRA accounts. Once this info is known you can decide on how to proceed.


I was thinking of opening a SIMPLE IRA at my business, but haven't done so yet (I actually recently posted about it oddly enough). I understand the deadline to do so is quickly approaching for this year. But a quick google search makes it looks like I can't roll over my pre-tax TIRA until two years have elapsed since the first participation? Correct?


Yes, 2 years must pass before you can roll another plan into a SIMPLE IRA, however if you are thinking of the SIMPLE account to roll your pre tax TIRA balance into, that will not help in doing a back door Roth. The pre tax balance must go into a non IRA plan such as a 401k. It would be solo 401k if the only employee is yourself and spouse.

There are other choices as well including paying the excise tax if your gains are large enough. This will keep the gains in the Roth if you withdraw just the contributions after 10/15, but you will owe the 6% excise tax.


What is this 10/15 deadline that you refer to? Did you mean 4/15?


No. The deadline to recharacterize or remove a 2019 IRA contribution is 10/15/2020 providing you either file your 2019 return by 4/15 or file an extension by 4/15. If you don't file, then the deadline would be 4/15. The 10/15 date is referred to as the "extended due date". If you want to use the time after next 4/15 before acting, then you would probably file an extension to avoid having to amend your 2019 return.

OR - if your modified AGI will drop in 2020, you can let the contribution stay in the Roth and apply it to 2020 on Form 5329.


Unfortunately as a small-business owner, I think I'm going to have to accept that at least for our current situation, our MAGI is going to be unknowable (or close enough to the line to make a difference) until after each tax year passes. I used to just wait till tax time to see if I could contribute at all, but got ahead of myself this year (I think).





So, there are actually 4 possible choices. Given that the year is almost 75% gone and your contributions will have to be dealt with in some manner, and because the deadlines to withdraw or recharacterize are over a year away, probably best to do nothing until your actual MAGI for 2019 is known around Feb or March, 2020. At that point you can figure the amount of gain or loss, you will know your permitted Roth contribution or deduction amount if your recharacterize, and will know your company retirement plan options. You also have until 4/15 to make additional IRA contributions for 2019.

Flyer24
Posts: 976
Joined: Sun Apr 08, 2018 4:21 pm

Re: Potential excess ROTH

Post by Flyer24 » Thu Sep 12, 2019 6:59 am

samsdad wrote:
Wed Sep 11, 2019 11:37 am
I need advice on what to do. I've been contributing to my newly opened (2019) Roth throughout the year thinking that DW and I were going to be under the income phaseout/cutoff. Turns out we might be over, if my small business gets a big order in the next few months (looks increasingly likely).

To make matters worse, I converted 10,453.52 from my tIRA to my Roth earlier this year (that's how confident I was that we were going to be well under the phaseout/cutoff).

Given the above, I've stopped all contributions to my Roth pending what comes up in my business.

Let's assume I go over the income limit (great problem to have I suppose).
To avoid the excess contributions tax:

withdraw the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
withdraw any income earned on the excess contribution.
See Pub 590-A for certain conditions that may allow you to avoid including withdrawals of excess contributions in your gross income.
https://www.irs.gov/retirement-plans/pl ... ion-limits

Questions:

1. I understand the above to mean that I can withdraw the contribution while avoiding a 6% tax penalty, but will have to pay 10% tax on the income earned on the excess contribution absent the usual conditions? Correct?

2. Getting back to that aforementioned 10k conversion. So, as I type this my total Roth amount is about 15k. I've contributed 2769.17 (strange amount due to Fidelity rewards points being deposited there). I have 2473.09 in gains as I type this. Some of those gains comes from that 10k that I converted, of course. So, how much of that is needs to be withdrawn to be taxed at that 10%?

3. Wading deeper into the waters, I understand that I can re-characterize the Roth contributions to a tIRA. Will this potentially solve my problem?

A recharacterization allows you to treat a regular contribution made to a Roth IRA or to a traditional IRA as having been made to the other type of IRA.

. . .

To recharacterize a regular IRA contribution, you tell the trustee of the financial institution holding your IRA to transfer the amount of the contribution plus earnings to a different type of IRA (either a Roth or traditional) in a trustee-to-trustee transfer or to a different type of IRA with the same trustee. If this is done by the due date for filing your tax return (including extensions), you can treat the contribution as made to the second IRA for that year (effectively ignoring the contribution to the first IRA).
https://www.irs.gov/retirement-plans/ir ... tributions (my emphasis)

To make matters interesting, I've already made 1347.69 in contributions to my tIRA this year. :D

FWIW, I'm not currently covered by a retirement plan at work; DW is, and is maxing out her 401k.

4. If I can or should re-characterize, I would obviously fall under the 6k limit with my prior 1347.69 straight contribution to my tIRA plus the 2769.17 that I've contributed to my Roth this year (4116.86). If I include the entirety of the 2473.09 in gains, I'll be over. So, again, how much of those gains are calculated as being part of the excess?

HELP!
Just answering your very last question. Your gains do not count towards your contribution limits.

retiredjg
Posts: 37402
Joined: Thu Jan 10, 2008 12:56 pm

Re: Potential excess ROTH

Post by retiredjg » Thu Sep 12, 2019 7:07 am

samsdad wrote:
Wed Sep 11, 2019 11:37 am
1. I understand the above to mean that I can withdraw the contribution...
If you decide to go this route, do not just take out the money yourself. Have your custodian do it so that the 1099 will be coded correctly.

Topic Author
samsdad
Posts: 723
Joined: Sat Jan 02, 2016 6:20 pm

Re: Potential excess ROTH

Post by samsdad » Thu Sep 12, 2019 8:25 am

Thanks again to all of you!

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