Author Topic: Roth IRA-Money already invested but we *might* earn too much  (Read 360 times)

afuera

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Roth IRA-Money already invested but we *might* earn too much
« on: September 12, 2017, 12:56:32 PM »
I was hoping for some guidance on how to handle our specific potential logistical issue regarding our Roth IRAs.
Hubs and I both maxed out our 2017 Roth IRAs before March 2017.  At the time, our taxable income did not exceed the limits.  I have since gotten a substantial raise and started doing a Mega Backdoor Roth within my 401K.  I'm trying to figure out how to withdraw/convert our earlier contributions should we exceed the $184,000/$194,000 income limits by EOY and if rIRAs are even worth it since I am able to contribute 23% of my income into Roth 401K thanks to the Mega Backdoor method.

Below is a little more information on the specific numbers I am talking about.

Jan 2017:
Hubs:
Salary: $84,000
Pre-Tax 401K deductions: $18K
HSA: $2,900 (employer contributes $500)





Me:
Salary: $99,000
Pre-Tax 401K deductions: $18K
HSA: $2,900 (employer contributes $500)

April 2017:
Hubs:
Salary: $84,000
Pre-Tax 401K deductions: $18K
HSA: $2,900 (employer contributes $500)





Me:
Salary: $107,200
Pre-Tax 401K deductions: $18K
After-Tax Converted to Roth 401K deductions: $24,656
HSA: $2,900 (employer contributes $500)

Hubs Roth IRA Balance: $11,979.52
My Roth IRA Balance: $19,101.93

Both of our IRAs are with Vanguard invested 100% VTSAX, if it matters.  I realize that in order to a backdoor Roth IRA we would contribute $5500 into a traditional IRA and then convert it to Roth the next day (and that is what we would do next year if our income exceeds the limits) but what do you do if the money has already been invested as Roth since the beginning of the year, has had substantial gains, is all mixed in with your older/legal Roth monies, and may become illegal by year end?  What fees/taxes might be involved in that process and how messy/time consuming is it?  Thank youuuuuuuu.




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Lady SA

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Re: Roth IRA-Money already invested but we *might* earn too much
« Reply #1 on: September 12, 2017, 03:38:43 PM »
Can you check your paystubs to see your qualifying income so far in 2017, then add in your future earnings for however many paychecks are left in 2017? I wouldn't panic quite yet-- you still had many months earlier in the year at the lower salary, so you won't truely be making $107k this year. I'm spitballing, but it could instead be more like $102k depending on when exactly the raise kicked in.

I also believe the earning limit in 2017 jumped up to $186k. You might squeak in just under the limit with a bit of investigation.

Edit: I see that you are both doing pre-tax 401k contributions. That means traditional contributions, not roth (after tax). Both $18k contributions (for a total of $36k) are subtracted from your earnings that are applicable to the roth earning limit. So actually, you should be fine if what you've included above is true, because while your gross salaries may be bumping up against that limit at around $186k, your modified adjusted gross income (which the limit is based on) is actually only $150k if you are contributing to a pre-tax 401k.

edit again: I really need to learn to read more closely. I see you changed your contribution strategy in 2017, but your dh is still doing pre-tax 401k contributions. So you aren't subtracting $36k, but you still can subtract $18k (from DH's contributions) from your gross income to get your MAGI (plus also subtracting both your HSA contributions--those are pretax as well). That still leaves you a bit of breathing room from that roth income limit for this year.

Basically, the math is a bit fuzzy, but you shouldn't be basing your income limits on your gross income. Calculate your actual MAGI and the limit is based on THAT number. With pretax deductions and 401k contributions, your MAGI drops and gives you more wiggle room before you hit the income limit. I'm not super familiar with the mega backdoor roth 401k option and how that affects MAGI (pretax? post tax? I get confused) so I would run your own calculations to see where your MAGI is. But based solely on your dh's pretax contributions, I would say you are still under the limit for 2017 even with your raise.
« Last Edit: September 12, 2017, 03:56:34 PM by Lady SA »
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nereo

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Re: Roth IRA-Money already invested but we *might* earn too much
« Reply #2 on: September 12, 2017, 04:15:29 PM »
Quote
what do you do if the money has already been invested as Roth since the beginning of the year, has had substantial gains, is all mixed in with your older/legal Roth monies, and may become illegal by year end?  What fees/taxes might be involved in that process and how messy/time consuming is it?  Thank youuuuuuuu.

Should you determine that you are indeed 'over the limits' this can be easily corrected without penalty provided you do so when you normally file taxes (which for most of us is April 2018).
In such a case what you need to do is remove both the contributions and any earnings before you file your taxes, generally April 2018 unless you file differently.

As long as you do this before your tax-filing deadline no further documents are needed - though you will need to pay the applicable taxes on that money.

If it is after the filing deadline but within 6 month you can still remove the contribution and any earnings, but you will need to file an amended tax return.
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secondcor521

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Re: Roth IRA-Money already invested but we *might* earn too much
« Reply #3 on: September 12, 2017, 04:50:00 PM »
Both of our IRAs are with Vanguard invested 100% VTSAX, if it matters.  I realize that in order to a backdoor Roth IRA we would contribute $5500 into a traditional IRA and then convert it to Roth the next day (and that is what we would do next year if our income exceeds the limits) but what do you do if the money has already been invested as Roth since the beginning of the year, has had substantial gains, is all mixed in with your older/legal Roth monies, and may become illegal by year end?  What fees/taxes might be involved in that process and how messy/time consuming is it?  Thank youuuuuuuu.

Relax, you're going to be OK.

As a previous poster points out, the limits are related to your AGI, not your overall income, so you may not need to do anything.

If you do happen to exceed the limits for contributing to a Roth, you have two choices:

1.  Withdraw your Roth contributions before you file taxes next year.  You will owe taxes on any earnings attributable to your contributions (because the contribution was not allowed, the earnings are not tax-deferred) and possibly a 10% penalty on the earnings portion (because it turns out not to be a qualified withdrawal).
2.  Recharacterize your Roth contributions, along with any earnings attributable thereto, into a traditional IRA.  If you do this, there will be no taxes and there will be no 10% penalty.  If you already have a traditional IRA that contains deductible contributions, I would recommend a second, non-deductible traditional IRA so you can keep track of things more easily, although that's not strictly necessary from an IRS point of view.

In either case, Vanguard will not charge you any fees to do this.  They also will automagically include any earnings (or losses) attributable to your contributions.  Just give them a call in the spring and explain what happened; they handle these kinds of things all the time.  They will probably have you fill out a form and mail it in.

Finally, you may end up in a phase-out range in AGI where a Roth contribution is permitted but limited.  If so, all of the above still applies with the additional comment that you are permitted to do partial recharacterizations.  So maybe you contributed $5500 to your Roth IRA and were only permitted to contribute $3000; you can then recharacterize $2500 of your contribution into a non-deductible traditional IRA.

Good luck!
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Acastus

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Re: Roth IRA-Money already invested but we *might* earn too much
« Reply #4 on: September 17, 2017, 06:58:25 PM »
Your HSA and insurance premiums are also subtracted from your gross to get the final AGI. That adds another 6k to your headroom created by the deductible 401k. You can add a few hundred to bring them to $6700. It may be better to get the tax deduction at 25% tax bracket, especially if you are in a high tax state. You could save the difference in a taxable account. Your choice, of course.

MDM

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Re: Roth IRA-Money already invested but we *might* earn too much
« Reply #5 on: September 17, 2017, 07:56:06 PM »
As others have noted, you are fine for 2017.   With the most recent numbers you gave (even assuming they are correct for the whole year), your MAGI will be $149,400 - well under the $186K beginning of the Roth contribution phaseout.

For general edification, see IRA recharacterization - Bogleheads and Backdoor Roth IRA - Bogleheads.

Just checking: you have two individual insurance policies, with neither covering the other - correct?  That would allow the $6800 contribution from you and the employer(s).  If either of you covers the other, together you are subject to the $6750 family limit.