Infinite Loop in Roth Eligibility

[phildonnia]

Here's a weird thing I'm running into:

I over-contributed to my Roth for 2019.  My MAGI is in the "phaseout" range.

The IRS instructions are to have the excess returned, together with the earnings, and report the earnings as income.  (And pay a penalty on the earnings).

However, if I report the earnings as income, that will change my MAGI, which changes my eligibility, which makes more excess. 

How is this supposed to be handled?  I don't even know how much the earnings are until my broker calculates them after I ask for the return of contributions, based on what I think I'm eligible for, based on my MAGI, which depends on what the earnings are.

Should I:

• Return some random amount that will be guaranteed to be enough;
• Do nothing, pay a penalty, and take a corrective distribution later
• Something else I'm missing? 

[RWD]

Your Roth contributions shouldn't affect your MAGI because they are not deductible.

[terran]

Your Roth contributions shouldn't affect your MAGI because they are not deductible.

I believe the OP is saying the earnings on the excess contribution is what's increasing MAGI.

Theoretically there should be a point where the increased MAGI results in less than $1 increased excess, but I can see how that would be hard to figure out since you don't know the exact earnings until after the excess removal. I suppose the easy thing to do is to just overestimate a bit with the excess removal.

I assume you have a previously deducted traditional IRA balance? If not, you could just do do a backdoor Roth contribution instead by recharacterizing to traditional and then converting to Roth. You'll pay taxes on all earnings this way, so you might want to leave the amount you're allowed to contribute in Roth. The converted earnings will be taxable in 2020 and won't change your 2019 MAGI, so you can be more precise with the amount you recharacterize than could could be with excess removal.

[dandarc]

Not an infinite loop as terran points out.

If you want to get it exact, iterate filling out your return until you've got the amount of the excess contribution down to where further iteration does not change your MAGI, withdraw the indicated amount and you should be able to file any forms necessary. I wouldn't be shocked if you called your broker and they had some kind of calculator to figure this out - for a company like Vanguard, "need to withdraw excess contribution and I'm in the phase-out range - how much to not owe any penalty?" may well come up often enough that they've built something to figure that out.

[RWD]

Your Roth contributions shouldn't affect your MAGI because they are not deductible.

I believe the OP is saying the earnings on the excess contribution is what's increasing MAGI.

Ah, my apologies, I missed that little nuance. You should be able to get the right amount with binary search style recalculations pretty quickly.

[phildonnia]

I assume you have a previously deducted traditional IRA balance?  If not, you could just do do a backdoor Roth contribution instead by recharacterizing to traditional and then converting to Roth.

Yep, I already thought of recharacterizing it and doing a backdoor.  I can't because I already have a large pre-tax IRA.

The converted earnings will be taxable in 2020 and won't change your 2019 MAGI, so you can be more precise with the amount you recharacterize than could could be with excess removal.

If I recharacterize it, does it not add the earnings to my MAGI?  I might try that, even if I can't bring it back to the Roth. 

[dandarc]

Recharacterizing results in the contribution + related earnings moving over to the traditional IRA. No penalty, no change in income since the money comes out.

You do get to track the non-deductible amount of the contribution for decades. That or pay tax a second time on the contribution when you eventually withdraw.