Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

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BoglesRazor
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Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by BoglesRazor »

Hi all,

I am curious to know what happens if you deposit the full $6K into a Roth IRA and then you later disqualify for the same calendar year because your income grew too high (change jobs for a higher salary, inherit a lump sum, receive a settlement, side business pass through LLC, etc.). What will the IRS do? Will you have to then pay taxes on your Roth IRA contribution or do you still get to deposit it because your expected income was below the threshold of $140K (single filer) at the time of deposit?

Thank you in advance.
lessismore22
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by lessismore22 »

You will be required to pull that money back out, along with any gains. Failing to do so will cause you a penalty of I believe 6% every year that you don't.

ETA: This is very common. Many people contribute throughout the year only to find out they didn't qualify due to income increases.
tmcc
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by tmcc »

Why can’t you make a nondeductible tiRA contribution the. Immediately convert it to a rIRA instead?
alfaspider
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by alfaspider »

tmcc wrote: Tue Jan 12, 2021 12:35 pm Why can’t you make a nondeductible tiRA contribution the. Immediately convert it to a rIRA instead?
This. If there is any doubt about your income in 2021, your best bet is to just do this from the get-go.
jebmke
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by jebmke »

I think this is addressed in IRS Publication 590a
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samsoes
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by samsoes »

lessismore22 wrote: Tue Jan 12, 2021 12:33 pm You will be required to pull that money back out, along with any gains. Failing to do so will cause you a penalty of I believe 6% every year that you don't.

ETA: This is very common. Many people contribute throughout the year only to find out they didn't qualify due to income increases.
...and yet, every year, without fail, there's a thread on Bogleheads asking who is fully funding their Roth IRA for the year on January 1. Equally predictable are panic-laced threads throughout the year from folks who fully funded their Roth In January and now face the prospect of going over the limit due to an unforeseen increase in income (new job, bonus, etc.).

As that great 20th Century philosopher Yogi Berra once said, "it's deja-vu all over again."
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H-Town
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by H-Town »

alfaspider wrote: Tue Jan 12, 2021 12:36 pm
tmcc wrote: Tue Jan 12, 2021 12:35 pm Why can’t you make a nondeductible tiRA contribution the. Immediately convert it to a rIRA instead?
This. If there is any doubt about your income in 2021, your best bet is to just do this from the get-go.
This. Very simple solution.
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Nate79
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by Nate79 »

H-Town wrote: Tue Jan 12, 2021 12:54 pm
alfaspider wrote: Tue Jan 12, 2021 12:36 pm
tmcc wrote: Tue Jan 12, 2021 12:35 pm Why can’t you make a nondeductible tiRA contribution the. Immediately convert it to a rIRA instead?
This. If there is any doubt about your income in 2021, your best bet is to just do this from the get-go.
This. Very simple solution.
Well, this doesnt work for everyone. Many people have traditional IRAs that make this impractical.
H-Town
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by H-Town »

Nate79 wrote: Tue Jan 12, 2021 1:00 pm
H-Town wrote: Tue Jan 12, 2021 12:54 pm
alfaspider wrote: Tue Jan 12, 2021 12:36 pm
tmcc wrote: Tue Jan 12, 2021 12:35 pm Why can’t you make a nondeductible tiRA contribution the. Immediately convert it to a rIRA instead?
This. If there is any doubt about your income in 2021, your best bet is to just do this from the get-go.
This. Very simple solution.
Well, this doesnt work for everyone. Many people have traditional IRAs that make this impractical.
Well, this as well. Don’t roll your 401k to tIRA. If you did, try to roll it back to your current employer 401k plan.
tashnewbie
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by tashnewbie »

I'm not a CPA or a tax attorney, but I think this is a common question on the forum.

If you made the contribution for 2020 but later learned your 2020 income was too high, then I think you have until your tax filing deadline (including extensions) to re-characterize the contributions along with the earnings (best option if you don't have any pretax IRA balances) or remove the contributions and earnings (you'll owe tax on the earnings). If you don't remove it, then you'll owe 6% excise tax for each calendar year that it remains in the Roth IRA (you can allocate the contribution to any amount that you're able to contribute directly in future tax years, but you'd continue to incur 6% annual tax until ineligible contribution is fully allocated or removed).

If you can opt to re-characterize the contribution, it'll be as if you never made a Roth IRA contribution and did a Traditional IRA contribution from the start. Then you can convert the TIRA balance to Roth IRA. These 2 steps are known as the Backdoor Roth. Call the custodian of your Roth IRA to do the re-characterization -- you can't do this yourself. They will know how to calculate the earnings and ensure the correct amount is re-characterized.

If you think your MAGI will be over or near the limits for 2021 and future years, just do the backdoor Roth instead of trying to do direct Roth IRA contributions. There's nothing that prohibits anyone from doing the backdoor Roth (I wouldn't do it if you have any pretax IRA balances (SEP, SIMPLE, Traditional, Rollover) because of the pro rata rule).
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BoglesRazor
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by BoglesRazor »

Hi All,

Thank you for the information. To clarify, I am changing jobs. I do not have a traditional IRA in any sense and I only have a Roth IRA and Roth 401K. However, from my understanding, my employer match (~$4K total) is not considered Roth and I believe it will turn into a traditional IRA. I mostly use two brokerages, Schwab and Folio Investing, for my Roth IRA. Folio was recently bought by Goldman Sachs and most of the clients like me are being pushed to Interactive Brokers (the transfer is tomorrow). I only have a small amount in this Roth IRA (something like $3-4K) and so this is where I wanted to invest my newly added $6K contribution for 2021. However, since I am leaving my company, I want to roll the Roth 401K to Schwab's Roth IRA. Will this also roll my employer match into a non-existent traditional IRA at Schwab if I roll the whole account or can I somehow "break it up" and roll the employer contribution to Interactive Brokers and then the rest of the Roth 401K to Schwab? I don't know how IBRK works, but I do not plan on being a day trader and I am more comfortable with my 401K being at Schwab. IBKR has other features that Schwab doesn't offer so I don't mind having this account to "play with." However, I don't know the best route to this process. I have never done a Backdoor Roth and I do not know what the best solution is. What are your thoughts? I really don't want to move my whole 401K to IBKR as this is dangerous. I mostly want to passively invest, but I don't have a choice with Folio transferring me to IBKR.

Thank you in advance!
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Duckie
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by Duckie »

BoglesRazor wrote:I do not have a traditional IRA in any sense and I only have a Roth IRA and Roth 401K. However, from my understanding, my employer match (~$4K total) is not considered Roth and I believe it will turn into a traditional IRA.
If you roll the Roth 401k to a Roth IRA you can roll the pre-tax 401k to a TIRA. Or you can roll the pre-tax 401k to a Roth IRA and pay the taxes. Or you can leave the entire 401k (Roth & pre-tax) where it is and once you start your new job, find out if the employer retirement plan will take incoming rollovers and has decent options. If so, you could roll the Roth 401k into a Roth IRA and the pre-tax 401k into your new employer plan.

With only $4K pre-tax I would roll the entire 401k into the Roth IRA and pay the taxes on the $4K.
However, since I am leaving my company, I want to roll the Roth 401K to Schwab's Roth IRA. Will this also roll my employer match into a non-existent traditional IRA at Schwab if I roll the whole account or can I somehow "break it up" and roll the employer contribution to Interactive Brokers and then the rest of the Roth 401K to Schwab?
It might be possible to roll the Roth 401k to a Roth IRA at one brokerage and the pre-tax 401k to a TIRA at another brokerage, but that won't solve the problem. You will still have a TIRA and the pro-rata rule will still apply if you use the backdoor Roth method.
exodusNH
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Re: Any CPAs or Tax Attorneys here? Roth IRA Limitations Question

Post by exodusNH »

BoglesRazor wrote: Tue Jan 12, 2021 3:11 pm Hi All,

Thank you for the information. To clarify, I am changing jobs. I do not have a traditional IRA in any sense and I only have a Roth IRA and Roth 401K. However, from my understanding, my employer match (~$4K total) is not considered Roth and I believe it will turn into a traditional IRA. I mostly use two brokerages, Schwab and Folio Investing, for my Roth IRA. Folio was recently bought by Goldman Sachs and most of the clients like me are being pushed to Interactive Brokers (the transfer is tomorrow). I only have a small amount in this Roth IRA (something like $3-4K) and so this is where I wanted to invest my newly added $6K contribution for 2021. However, since I am leaving my company, I want to roll the Roth 401K to Schwab's Roth IRA. Will this also roll my employer match into a non-existent traditional IRA at Schwab if I roll the whole account or can I somehow "break it up" and roll the employer contribution to Interactive Brokers and then the rest of the Roth 401K to Schwab? I don't know how IBRK works, but I do not plan on being a day trader and I am more comfortable with my 401K being at Schwab. IBKR has other features that Schwab doesn't offer so I don't mind having this account to "play with." However, I don't know the best route to this process. I have never done a Backdoor Roth and I do not know what the best solution is. What are your thoughts? I really don't want to move my whole 401K to IBKR as this is dangerous. I mostly want to passively invest, but I don't have a choice with Folio transferring me to IBKR.

Thank you in advance!
Since your employer match is $4K, it's safe to assume that your entire 401K is over $5,000. In that case, you can legally just leave the 401K where it is. Even if they /want/ you to pull the money, you're under no obligation to do so.

If your new employer has a 401K, you can roll all of that over into it.

If you take the match as a traditional IRA, you're going to have to pay taxes on it if you want to continue contributing to the Roth IRA.
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