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)
