Author Topic: Roth IRA Issue - Married Filing Separately  (Read 3616 times)

jexy103

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Roth IRA Issue - Married Filing Separately
« on: March 26, 2014, 07:25:01 PM »
Hello,

Background: I am currently in the process of a divorce, but on Dec 31, we were married, so we have to do our taxes as Married Filing Jointly or Married Filing Separately. (Please correct me if I'm wrong about any aspect of this post- that's why I'm posting to this forum. :-) ) I wanted to file Married Filing Jointly, since it is less complicated, similar to last year, and is typically more beneficial than Separately. However, my soon-to-be ex wanted to file Separately "because we're getting a divorce." (I make decisions based on logic, he typically bases his decisions on emotion.) At the time (early February or so), I didn't see it as a big deal, so I agreed to file Separately. Since then, I've been waiting to receive the Divorce Decree from him with his signature before I filed my tax return (so he couldn't change his mind and I'd have to amend). I received the Decree over the weekend and started my return today.

Situation: I made about $35,000 of taxable income in 2013, and like a good FIRE-to-be, I maxed out my IRA (I chose to put all $5,500 in a Vanguard Roth IRA). I also have contributed $458.33 ($5,500/12) in January, February and March, for a total of $1,374.99 so far this year. When entering my tax information, I was very confused/surprised when my estimated refund dropped significantly (a few hundred) after entering my Roth IRA information. Roth contributions are post-tax, so I thought it this was very strange. After some quick research (TurboTax help- see attachment), it appears that Married Filing Separately means that I am only allowed $10,000 MAGI. Since I made ~$35,000, the entire $5,500 (plus gains) is subject to a 6% annual fee for every year it remains in my Roth IRA! :-o

As it now stands, I owe a 6% penalty on the $5,500, and since I've already contributed $1,375 to 2014, I'll owe 6% on that (as a continued excess). Then, I also won't be able to contribute any more to the Roth for the rest of 2014 and $1,375 I can't contribute in 2015 (or pay the penalty), so that's $5,500 of lost opportunity to contribute (and all the gains that I potentially could have earned on it over the next 10-15 years or more).

Math Results:
Tax return reduced from $447-$117 = $330 (which I believe is the 6% of 2013's $5,500)
2014's Contributions Excess Fee = $1,374.99 * .06 = $82.50
Lost Opportunity of $5,500 = $5,500 * .08 = $440 per year (at assumed 8% growth)
Total Cost between now and April 2015 = approx. $852 -$1,000
Total Cost could be as much as $10,000, including lost opportunity of gains over 20 years

Options:
1) Ask the ex if he has filed his taxes yet, and if not, ask if he will reconsider and file Jointly. (This may require a monetary incentive to accomplish, if even possible.)
2) Recharacterize the $5,500 (plus gains) to a Traditional IRA. (This may be the easiest option.)
3) Leave the $5,500 and $1,375 where it is and just accept the tax consequences.
4) Withdraw the $5,500 (plus gains) and... put it in a taxable account? (This is the option least preferred.)

I've attached the text that TurboTax included in their "Explain this" help article. Any advice anyone may have for me would be greatly appreciated!

(Edited to correct terminology)
« Last Edit: March 26, 2014, 07:46:41 PM by jexy103 »

Cheddar Stacker

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Re: Roth IRA Issue - Married Filing Separately
« Reply #1 on: March 26, 2014, 08:28:20 PM »
Sorry to hear about the divorce (or congratulations if it pleases you).

Married filing separate is awful for 100 reasons, but I still wouldn't recommend filing a joint return with your ex, so I would throw option 1 out. It doesn't sound like you are on the same page right now, and it's not worth it if it will cause any additional "problems".

Bad news - you can't make a Roth contribution for 2013. Good news - this only affects 2013 because it's the only year you are filing MFS since you will be single in 2014. Even better good news - I think you can simply change your perspective for one year, re-characterize this to a Traditional IRA for 2013 (if that's still possible), and get a $5,500 tax deduction out of this which will reduce your refund quite a bit. You would likely also get the savers credit unless that is also thrown out when you file MFS.

huadpe

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Re: Roth IRA Issue - Married Filing Separately
« Reply #2 on: March 26, 2014, 08:55:27 PM »
According to the IRS website, you can withdraw the contribution up through Apr. 15 as an excess contribution and pay no penalty:

"Withdrawal of excess contributions.   For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made."

http://www.irs.gov/publications/p590/ch02.html

As to the gains, you will need to withdraw them as well, on a pro-rata basis with any other gains within your account, as explained here:

http://www.investopedia.com/articles/retirement/04/042804.asp

I would do option 2 if you're in the 25% bracket, and option 4 if you're in the 15% bracket.  Reason being that in the 25% bracket you're getting a pretty good tax break this year, but in the 15% bracket you're not saving much, and putting the money in a spot where it won't get advantageous cap gains/dividend treatment on withdrawal.

Option 3 is no good at all, and Option 1 doesn't sound good, depending on your relationship with the ex.  And I'm guessing not great (from the whole being the ex part).

Nicster

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Re: Roth IRA Issue - Married Filing Separately
« Reply #3 on: March 26, 2014, 09:02:12 PM »
A similar thing happened to me when I got divorced.  I re-characterized it from a Roth to a traditional IRA. I think you have until April 15th.

We did file jointly because it did make more sense. My ex husband took $ out of his 401k which put our joint income over the max allowable. It was not intentional on his part and it worked out okay.

Hang in there. Divorce is tough.

mlipps

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Re: Roth IRA Issue - Married Filing Separately
« Reply #4 on: March 26, 2014, 09:45:45 PM »
I imagine that life is pretty stressful right now. Try to keep this in perspective; in the grand scheme of things, $5,500 in contributions will not make or break your retirement. I would probably take the path of least resistance w/the ex because it just doesn't seem worth a battle to me.

T-Rex

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Re: Roth IRA Issue - Married Filing Separately
« Reply #5 on: March 27, 2014, 02:46:58 AM »
I had a similar problem, had them change my Roth contributions to 2014.

jexy103

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Re: Roth IRA Issue - Married Filing Separately
« Reply #6 on: March 27, 2014, 06:43:14 PM »
Thank you all for your advice and suggestions. I called him yesterday to see if he would consider filing Jointly but couldn't get ahold of him. If I can't get him to agree to file Jointly, I'll either recharacterize as Traditional or withdraw and put in taxable. Thanks for helping me think through this!

Cheddar Stacker

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Re: Roth IRA Issue - Married Filing Separately
« Reply #7 on: March 28, 2014, 09:30:35 AM »
...re-characterize this to a Traditional IRA for 2013 (if that's still possible), and get a $5,500 tax deduction out of this which will reduce your refund quite a bit.

Sorry about this error I just noticed. Obviously I meant to say reduce your taxes/increase your refund. Oops!

Good luck jexy.