Married filing separately but accidentally contributed to Roth IRA

[Archipelago]

Hello,

My partner and I maxed our Roth IRAs in early 2023. I just recently found out we need to do our taxes MFS and was unaware Roth contributions are not allowed if we have earned income above $10,000. Is there a workaround to avoid a tax bill, penalties, but retain the ability to still contribute to our Roths?

1. Recharacterize the Roth contributions as Traditional IRA contributions? (with MFS you can still contribute to a tIRA but you don't get to deduct your contributions).
2. Convert tIRA to Roth?

Would this work and are there any tax implications?

Also, we plan to MFJ in 2024 so if there's another workaround to recharacterize 2023 contributions as 2024 contributions, that may work too, but we'd still have to pay taxes and penalties on any gains over the last year.

Thank you!!

[seattlecyclone]

Yeah recharacterizing to go through the backdoor would be a fine workaround, assuming you have no pre-tax IRA already and can therefore take advantage of the backdoor.

A recharacterization essentially lets you go back in time and treat it as though you made the contribution directly to your traditional IRA early in 2023. Based on market performance over the past year you'll probably find that your Roth conversion would then be partly taxable up to however much your investment grew since your contribution. The tax would count toward your 2024 income since Roth conversions are always taxed in the year they actually happen.

Alternatively you could leave the money where it is and pay the 6% excess contribution penalty. That 6% penalty is charged every subsequent year until you correct the excess contribution, but one of the ways you can correct it is to contribute less than your limit in the following year. That would probably mean limiting yourself to a $500 Roth contribution this year (since the limit went up). You may therefore find the recharacterization->conversion to be the better option even if the tax ends up costing more than 6%.

[secondcor521]

Why do you need to file MFS?

[Archipelago]

Yeah recharacterizing to go through the backdoor would be a fine workaround, assuming you have no pre-tax IRA already and can therefore take advantage of the backdoor.

A recharacterization essentially lets you go back in time and treat it as though you made the contribution directly to your traditional IRA early in 2023. Based on market performance over the past year you'll probably find that your Roth conversion would then be partly taxable up to however much your investment grew since your contribution. The tax would count toward your 2024 income since Roth conversions are always taxed in the year they actually happen.

Alternatively you could leave the money where it is and pay the 6% excess contribution penalty. That 6% penalty is charged every subsequent year until you correct the excess contribution, but one of the ways you can correct it is to contribute less than your limit in the following year. That would probably mean limiting yourself to a $500 Roth contribution this year (since the limit went up). You may therefore find the recharacterization->conversion to be the better option even if the tax ends up costing more than 6%.

Good info here, thanks a lot!

Why do you need to file MFS?

Student loan payments blowing up. $1300/month if we MFJ and $0/month if MFS. In 2025 my partner will qualify for loan forgiveness, and we can get reimbursed for any loan payments made.

[Archipelago]

As a follow up to this topic, a 20-minute phone call with Vanguard got this ironed out. The CSR was very knowledgeable and helpful.

We recharacterized 2023 contributions from Roth --> Traditional. The CSR set up a form on their end, sent it over, and I signed it. This recharacterization will take place in a few days.

Once the money hits Traditional IRA, I will immediately convert the funds to a Roth IRA. This will trigger a taxable event in which I'll pay taxes and penalties on gains.

I had a SEP IRA open from a previous employer with about $3500 in it. The CSR let me know that this would also need to be converted to Roth in order to do the backdoor conversion. This will also trigger a taxable event but is worth it because it will allow us to keep using the backdoor for years to come.

[terran]

As long as the gains are converted to Roth (not withdrawn) you won't owe penalties, only taxes on the gains.

If you still have self employment income you could open a solo 401(k) and roll the SEP IRA over to that (only an option at certain custodians). Probably not worth doing for only $3500 unless you plan to continue contributing to it.

[Archipelago]

As long as the gains are converted to Roth (not withdrawn) you won't owe penalties, only taxes on the gains.

If you still have self employment income you could open a solo 401(k) and roll the SEP IRA over to that (only an option at certain custodians). Probably not worth doing for only $3500 unless you plan to continue contributing to it.

I do already have a Solo 401(k), but it's with another custodian (Fidelity). It's a bit too late in the game to change it, but that's alright because I'm willing to take the tax hit in exchange for the ability to keep the backdoor option open.

[roomtempmayo]

We recharacterized 2023 contributions from Roth --> Traditional. The CSR set up a form on their end, sent it over, and I signed it. This recharacterization will take place in a few days.

I'm in exactly the same spot.  Contributed some funds to a 403b with Roth status in 2023, but now realize I need to file MFS.

I just spent 20 minutes on the phone with someone at my plan manager who seemed very confused, checked with a manager, and then vaguely told me it's not possible.

Is there a name of the form that needs to be filed?  Or some other magic words to say so a customer service person will be able to figure out what to do?

If I can't get my retirement manager to figure it out, I'm going to need to hire someone else to get it done.

[terran]

@roomtempmayo, You're in a different situation. There are no income or filing status restrictions on contributing to a workplace plan (only IRAs) and you can't recharacterize a workplace plan. You're fine as is.

[roomtempmayo]

@roomtempmayo, You're in a different situation. There are no income or filing status restrictions on contributing to a workplace plan (only IRAs) and you can't recharacterize a workplace plan. You're fine as is.

Oh, I didn't realize there was no restriction on 403bs, and that IRAs were handled differently.  That's extremely helpful.  I had assumed they were the same!