Excess Roth IRA Contributions Help for a Big Dummy

[William Cannon]

At the end of 2018, I opened a Roth IRA for my wife, dropped $5.5k in the account, and invested in the S&P.  2018 was a good year financially so I thought I was being slick.  While starting 2018 income taxes, I've come to find out this was stupid since our AGI > $199k (above the limit).  It also appears that I can't recharacterize to a traditional IRA for a tax benefit.

What do I do?  I'm thinking I need to take an IRA distribution for the excess contribution/earnings (the $5.5k + earnings) and use that money to bump up my 401k contributions (i.e. to cover deficit in paycheck).  Is there a better option?  Can I recharacterize it to a traditional IRA and then recharacterize to a backdoor Roth in the future?  Is that possible?  I need to learn about backdoor Roths.


BTW, I've already repeated this mistake in 2019.  2019 AGI forecast says we won't be eligible and I've already deposited the $6k for 2019 Roth IRA.




Thanks in advance,
WC

[Nothlit]

Can I recharacterize it to a traditional IRA and then recharacterize to a backdoor Roth in the future?  Is that possible?  I need to learn about backdoor Roths.

Do you have any existing pre-tax IRAs of any kind? If not, the backdoor Roth IRA is a possibility for you.

You would need to recharacterize your $5500 2018 and $6000 2019 Roth IRA contributions as traditional IRA contributions. You would file 2018 Form 8606 Part I now (along with your 2018 tax return) to report the $5500 2018 nondeductible traditional IRA contribution. Then convert the $11500 traditional IRA to a Roth IRA. Next year you would file 2019 Form 8606 reporting the $6000 nondeductible trad IRA contribution in Part I and the $11500 Roth conversion in Part II.

Note the terminology here is precise: recharacterization, then conversion. It's confusing if you use those terms interchangeably because they have distinct meanings.

[William Cannon]

Do you have any existing pre-tax IRAs of any kind? If not, the backdoor Roth IRA is a possibility for you.

Nope, no other IRAs to speak of period.

Thanks for the advice and the clarification on the terminology.

[William Cannon]

Do I have the understanding correct that for 2018:
a) I can only recharacterize $5500 from Roth to the non-deductible tIRA. 
b) Any attributed earnings will need to be withdrawn as an excess distribution

[Nothlit]

You can recharacterize $5500 worth of contributions, and the associated earnings go along for the ride. The IRA provider should have a procedure for figuring that out.

[William Cannon]

You can recharacterize $5500 worth of contributions, and the associated earnings go along for the ride. The IRA provider should have a procedure for figuring that out.

If I do that, Turbotax flags the earnings (~$700) as excess contribution and penalizes them at 6%.

[Nothlit]

When you recharacterize, you treat it as if the contributions were of the other type all along. So from TurboTax's perspective it would be as if you made $5500 of traditional IRA contributions instead of $5500 of Roth IRA contributions. The only reason I can think that TT would be flagging the earnings as excess contributions is if you're telling it that the earnings were contributions (i.e., telling it you contributed $6200 to a trad IRA), which is incorrect.

[EricEng]

Fill out a Removal of Excess contribution form to get it out of the Roth.  I did the same mistake this year.  They will calculate your gains/losses and take the appropriate amount or you can try to calculate yourself.  From the way Ameritrade explained it to me, you have to make a nondeductible IRA contribution and then convert that entire account to Roth for your back door conversion (only option at your income level).  First step though is undo what you contributed.

Ameritrade's form is here:
https://www.tdameritrade.com/retail-en_us/resources/pdf/TDA1401.pdf
Other companies will have something similar.

[ladydi]

This has happened to me.  I called my Roth IRA provider (Fidelity) asked them what to do, and they told me.  It was somewhat of a hassle, but not hard.

https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning/correct-excess-IRA-contributions.pdf has a good explanation of how to treat excess traditional and Roth IRA contributions. Note that you can do either Option 1 (remove excess before tax filing deadline - April 15 if you don't extend), or Option 2 - recharacterize.  In Option 1, you pay tax and the 10% early withdrawal penalty on the earnings only.  In Option 2, you can redesignate as a traditional IRA contribution, but only up to the contribution amount. 

So should you do the traditional IRA (nondeductible) recharacterization of your contributions?  If you have either no IRAs or only nondeductible IRAs, then yes, you can do a clean back-door Roth conversion. If you have a mix of both deductible and nondeductible IRAs, then it isn't as beneficial.  You don't get to cherry-pick and just say I'm going to convert only the nondeductible IRA.  Recordkeeping is a hassle when you're mixing the deductible and nondeductible IRAs, so you might want to keep that in mind.  (I didn't do nondeductible IRAs for that reason.) See the "Nondectible contributions" discussion here:  https://www.fidelity.com/viewpoints/retirement/roth-IRA-common-questions