Author Topic: Adjusting overcontribution to Roth IRAs  (Read 567 times)

AZDuke06

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Adjusting overcontribution to Roth IRAs
« on: November 09, 2021, 09:13:30 AM »
Good morning,

My wife and I both made $6k contributions to our Roth IRA back in January for the year 2021.  As it turns out, it looks like we're going to make more than the combined income limit for the year, and thereby, we must take the original $6k out in addition to any profits accumulated during the year associated with each respective $6k contribution in relation to the original Roth. 

Could someone confirm that I have this correct?  Here's an example of my interpretation of how it would work...

So, let's say the Roth IRA had a $24,000 balance at the start of the year and I put in $6,000 on January 2nd.  That tells me that 20% of any profits would be attributed to the improper contribution.  So, let's say the balance at the end of the year hits $40k...that would mean a profit of 10k for the year, 2k of which are attributable to the improper 6k contribution.  Meaning, I'd need to withdraw the original 6k and the 2k of profit for a total of $8,000 withdrawal to square things up.  As a final step, the $2k would then need to be added back to wages/income to be taxed per my usual rate.

Please let me know if I've missed anything and thanks for the help!

talltexan

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Re: Adjusting overcontribution to Roth IRAs
« Reply #1 on: November 09, 2021, 01:18:52 PM »
Is it possible to re-classify the income into the following tax year?

terran

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Re: Adjusting overcontribution to Roth IRAs
« Reply #2 on: November 09, 2021, 01:40:39 PM »
Are you just asking so you can make estimates of how much this will add to your taxable income? If so, then yes, it sounds like you have a good estimate. I wouldn't suggest just going in and making a withdrawal though. Better to call up your IRA custodian and tell them you need to remove an excess contribution. They'll figure out exactly how much you need to withdraw and they'll code it properly so it shows as a removal of excess contributions on the tax forms they send you and the IRS so you won't owe early withdrawal penalties (you'll still owe tax on the earnings as you've said).

Another option: do you have any previously deducted traditional IRA balances including rollovers from previous employer plans? If not you could instead call up your IRA custodian and tell them you need to recharacterize your contribution from Roth to traditional. The recharacterization makes it as if you contributed to traditional in the first place, so once it's been recharacterized to traditional you can proceed with a backdoor Roth contribution by rolling it over back into the Roth. You'll still owe tax on the gains you've had to date just like if you had contributed to a non-deductible traditional IRA and left it there for awhile before converted to Roth, but any future gains will grow tax free in the Roth just like any other Roth contribution.

RyanAtTanagra

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Re: Adjusting overcontribution to Roth IRAs
« Reply #3 on: November 10, 2021, 10:27:29 AM »
Better to call up your IRA custodian and tell them you need to remove an excess contribution. They'll figure out exactly how much you need to withdraw and they'll code it properly so it shows as a removal of excess contributions on the tax forms they send you and the IRS so you won't owe early withdrawal penalties (you'll still owe tax on the earnings as you've said).

Yes, this.  I did this a few years back.  For some reason I was way off in what I thought the income limits were for Roth, and over-contributed for 3 years.  The previous two years were a PITA (had to file adjustments), but if you figure it out in the year it happened, it's pretty straight forward.

AZDuke06

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Re: Adjusting overcontribution to Roth IRAs
« Reply #4 on: November 15, 2021, 12:39:24 PM »
Thanks everyone.

Texan - I can't do anything about that, its all W-2 income.

Terran/Ryan - This is good advice, thank you.  I will reach out to my administrator.  I was a little concerned i'd have to do an on-the-fly, day of withdrawal calculation myself that could end up being faulty.  I do not have an existing traditional IRA, only the Roth's, so I'll go the withdrawal route.

terran

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Re: Adjusting overcontribution to Roth IRAs
« Reply #5 on: November 15, 2021, 09:08:46 PM »
I do not have an existing traditional IRA, only the Roth's, so I'll go the withdrawal route.

Sounds like maybe I wasn't clear enough. Since you don't have a traditional IRA you'd be a good candidate for recharacterizing your Roth overcontribution to traditional and then converting the traditional to Roth. You'll have to pay tax on the gains you've had since you originally converted contributed, but you'll end up with it back in Roth.

If your income continues to be over the Roth contribution limit you might want to continue to follow this process in future years. (minus the recharacterization -- just contributed straight to traditional then proceed from there). This is colloquially known as the backdoor Roth if you you want to look for more information, or just see the link in my previous post.
« Last Edit: November 16, 2021, 11:20:35 AM by terran »

AZDuke06

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Re: Adjusting overcontribution to Roth IRAs
« Reply #6 on: November 16, 2021, 10:58:09 AM »
Ahhh I understand now.  Thanks!  Love the idea.

talltexan

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Re: Adjusting overcontribution to Roth IRAs
« Reply #7 on: November 19, 2021, 07:27:25 AM »
Thanks everyone.

Texan - I can't do anything about that, its all W-2 income.

Terran/Ryan - This is good advice, thank you.  I will reach out to my administrator.  I was a little concerned i'd have to do an on-the-fly, day of withdrawal calculation myself that could end up being faulty.  I do not have an existing traditional IRA, only the Roth's, so I'll go the withdrawal route.

I misspoke. I should have suggested reclassifying the "contributions" for the following year.

JoePublic3.14

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Re: Adjusting overcontribution to Roth IRAs
« Reply #8 on: November 21, 2021, 04:55:06 PM »
I just wanted to reinforce @terran 's point of just automatically assuming you will go over and use the Traditional to Roth as normal practice.

AZDuke06

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Re: Adjusting overcontribution to Roth IRAs
« Reply #9 on: November 24, 2021, 10:06:46 PM »
Yes, I am indeed expecting to be above income limits for Roth contribution from this point forward.  So, in your view, you're saying to each open a traditional IRA, make the yearly contribution, and roll the full balance over annually into the existing Roth's after paying the tax?

terran

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Re: Adjusting overcontribution to Roth IRAs
« Reply #10 on: November 25, 2021, 01:28:52 AM »
Assuming you don't already have a traditional IRA that was previously deducted (including rollovers from employer plans), then yes, and there should be hardly any taxes to pay as part of the rollover. If you contribute to a traditional IRA and don't deduct it then roll it over to Roth then only any gains in the account before the rollover are taxable, which should be minimal if you do it quickly.