Author Topic: Fixing IRA Contribution Mistakes  (Read 2583 times)

REfinAnon

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Fixing IRA Contribution Mistakes
« on: January 03, 2017, 10:27:20 AM »
It's the beginning of the year and I'm tying to clean up my financial house. One problem that I had is I made some disadvantageous contributions in the past that I want to rectify, but I'm not really sure what my options are.

In the past (2015-2016) I made contributions to a traditional IRA (both of $5500) for the tax year 2015 and the tax year 2016, the funds were invested in indexes immediately after making the contributions. When I filed my 2015 taxes in April of 2016, I discovered that my 2015 income was too high to take the deduction - oops. So this was essentially a waste and I did it for two years rather than one before figuring it out (my income for 16 will be higher than 15).

I believe - although I'm not really sure - that I can somehow convert these contributions to a Roth IRA fund but confirmation from those more knowledgeable would be helpful.

My question is, if I do make this change, what does this trigger on my taxes? What do I need to be aware of when I go to file? Can I just take $11000 from my traditional IRA - then move it to a Roth IRA without mentioning anything on my income taxes at all? What about the growth that these initial investments have had, how do I treat that?

I wish I had taken care of this sooner but had a really busy 2016. Any help would be very much appreciated.

Nothlit

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Re: Fixing IRA Contribution Mistakes
« Reply #1 on: January 03, 2017, 10:52:18 AM »
Note: I have not done any of this myself, so I do not speak from personal experience, but the two different procedures you want to investigate are "recharacterization" and "conversion". I believe you should be able to recharacterize your 2016 contribution from traditional to Roth. However, it's probably too late to recharacterize your 2015 contribution. So you could either leave the 2015 amount alone, or convert that traditional IRA into a Roth IRA, which is a different process from recharacterizing a contribution. In both cases you will need to work with your IRA custodian to do it properly. You can't just move the money around and not mention anything at all to the IRS.

secondcor521

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Re: Fixing IRA Contribution Mistakes
« Reply #2 on: January 03, 2017, 11:21:58 AM »
Nothlit is essentially correct.

You can recharacterize your 2016 contribution from your traditional IRA to your Roth IRA.  When you do so, your IRA custodian will also add or subtract any gains or losses associated with your contribution.  There is no need to report this contribution or recharacterization on your tax forms.  It is unlikely, but you may want to take a look at line 51 and Form 8880 to see if your contribution entitles you to the retirement savings tax credit.  You should keep track of your Roth IRA contribution, though, because it becomes important later when you start withdrawing money from it and filling out Form 8606.

You can convert money from your traditional IRA to your Roth IRA in any amount and at any time.  Although you can think of it as coming from your 2015 contribution or the earnings thereon, or even an earlier year contribution, the IRS doesn't care - all money coming out of a traditional IRA is treated as a distribution.  Note that if you do this conversion, the amount you convert will be subject to ordinary income tax.  Although in your case, since your 2015 contribution amount was nondeductible, you will only pay income tax on the percentage of your conversion amount that represents the pre-tax portion of your traditional IRA.  Use Form 8606 to figure out the amount of the conversion that is taxable - the result will be on line 15 of that form.  If you do this exercise, you will note that you should go back to your 2015 taxes and amend them to file a form 8606 to reflect the fact that your contribution to your traditional IRA in that year was nondeductible.

By the way, Form 8606 is confusing as heck to me.  I would strongly recommend reading the instructions very carefully and making sure that the results you get make sense to you and match what you read in plain language at sites like the IRS and Fairmark.

REfinAnon

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Re: Fixing IRA Contribution Mistakes
« Reply #3 on: January 03, 2017, 04:14:49 PM »
Thank you both. This sounds a little more complicated than I had hoped.

Ebrat

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Re: Fixing IRA Contribution Mistakes
« Reply #4 on: January 04, 2017, 07:34:00 AM »
Depending on how much you have in traditional IRAs, I would just leave the 2015 contribution alone.  I think that any conversion from trad to Roth will be taxed based on the proportion that was contributed pre- vs. post-tax.  For example, if you have 55,000 in there and only 5,500 was contributed post-tax, you'll pay taxes on 90% of whatever you convert to Roth.

The recharacterization of the 2016 contribution from trad to Roth is maybe easier than it sounds.  I just did one through Vanguard for the same reason, and there's a 3-4 page form online that you fill out and mail in.  I called up customer service and the rep walked me through the form.  I sent it in, and a few days later, everything was magically corrected.  You'll get a tax form, but it doesn't really have any effect on anything.  Just make sure you do the recharacterization by April 15.

Mezzie

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Re: Fixing IRA Contribution Mistakes
« Reply #5 on: January 04, 2017, 09:02:29 AM »
I'm possibly going to be in the same boat. I'll find out when I do taxes this year if the traditional IRA was the right choice, but I'm leaning towards Roth now. For the moment, I figure the money is saved away, and that's a good thing no matter what I have to do later. I'll keep an eye on this thread, though.

dandarc

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Re: Fixing IRA Contribution Mistakes
« Reply #6 on: January 04, 2017, 09:11:40 AM »
Recharacterize the non-deductible portion for 2016 for sure.  You have until April 15th or later if you file for an extension to do so.  If you're with Vanguard its a 5 minute phone call, in my experience.