Tax Impact of Excess Roth Contributions?

[Frugal716]

Early in 2016 I contributed the maximum $5500 into our Roth IRA's and our income ended up exceeding the MAGI limit to where we can only contribute roughly ~$3200 (good problem to have!). My plan is to remove the excess contribution prior to filing my taxes and calculate the net income based on return between the excess contribution and now.

I'm pretty comfortable with the net income calculation itself, but how does this not become a circular reference within my taxes? For example:

1. I calculate net income due to excess to be $500.
2. My IRA provider distributes the excess plus my calculated net income, the income portion of which counts as earnings in 2016
3. These earnings increase my MAGI, which reduces the amount I can contribute to a Roth, with increases the excess, and then increases net income again
4. Repeat steps 2 and 3?

What am I missing?  Do the earnings not hit 2016 income but actually 2017?


Lesson learned: Don't contribute to a Roth until your taxes are complete!

[Aggie1999]

Early in 2016 I contributed the maximum $5500 into our Roth IRA's and our income ended up exceeding the MAGI limit to where we can only contribute roughly ~$3200 (good problem to have!). My plan is to remove the excess contribution prior to filing my taxes and calculate the net income based on return between the excess contribution and now.

I'm pretty comfortable with the net income calculation itself, but how does this not become a circular reference within my taxes? For example:

1. I calculate net income due to excess to be $500.
2. My IRA provider distributes the excess plus my calculated net income, the income portion of which counts as earnings in 2016
3. These earnings increase my MAGI, which reduces the amount I can contribute to a Roth, with increases the excess, and then increases net income again
4. Repeat steps 2 and 3?

What am I missing?  Do the earnings not hit 2016 income but actually 2017?


Lesson learned: Don't contribute to a Roth until your taxes are complete!

Why not just re-characterize the excess Roth contributions and earnings on those contributions into a tIRA? Then you don't have to claim additional earnings on the growth. You just can't deduct the money going into the tIRA. Someone correct me if any of this is wrong.

As for your question about the circular nature if you simply cash out the earnings, I have no idea. Perhaps the tax laws say the process stops after the first correction. No clue though.

[Cherry Lane]

I've done exactly as the poster above described.  Just recaracterize the amount of your excess contribution as a non-deductible traditional IRA.

My IRA is with Vanguard. They require an actual signature to make the recaracterize, so it takes a few extra days for mail (so give yourself some extra time before the tax filing deadline). You tell them how much of your contribution you want to recaracterize and they will move that amount plus any earnings on those contributions, to a traditional IRA. Then just file your taxes as if you'd contributed the correct amount all along.

If you don't have other funds in a traditional IRA, you can then to a conversion back to a Roth (the back door method), and you are right back where you wanted to be.  (I haven't done that part.)

[johnny847]

I've done exactly as the poster above described.  Just recaracterize the amount of your excess contribution as a non-deductible traditional IRA.

My IRA is with Vanguard. They require an actual signature to make the recaracterize, so it takes a few extra days for mail (so give yourself some extra time before the tax filing deadline). You tell them how much of your contribution you want to recaracterize and they will move that amount plus any earnings on those contributions, to a traditional IRA. Then just file your taxes as if you'd contributed the correct amount all along.

If you don't have other funds in a traditional IRA, you can then to a conversion back to a Roth (the back door method), and you are right back where you wanted to be.  (I haven't done that part.)

That's not true. On Wednesday I was able to recharacterize my tIRA contribution without sending in a form. This may be because I set up voice verification with Vanguard. I'm not sure.

By the way, they will move the amount plus any associated earnings or losses on those contributions. And that's happened to me before - I recharacterized $531 of my contribution one year, but because the IRA had lost money, only $513 was moved over.

[Cherry Lane]

I've done exactly as the poster above described.  Just recaracterize the amount of your excess contribution as a non-deductible traditional IRA.

My IRA is with Vanguard. They require an actual signature to make the recaracterize, so it takes a few extra days for mail (so give yourself some extra time before the tax filing deadline). You tell them how much of your contribution you want to recaracterize and they will move that amount plus any earnings on those contributions, to a traditional IRA. Then just file your taxes as if you'd contributed the correct amount all along.

If you don't have other funds in a traditional IRA, you can then to a conversion back to a Roth (the back door method), and you are right back where you wanted to be.  (I haven't done that part.)

That's not true. On Wednesday I was able to recharacterize my tIRA contribution without sending in a form. This may be because I set up voice verification with Vanguard. I'm not sure.

I've never tried to do it over the phone, I just know it can't be done online.  Here's what the Vanguard website says:

How to initiate a recharacterization
Recharacterizations can't be completed online, so use this form to get started:
Download & print an IRA Recharacterization Form PDF
Or call us at 800-984-5931, and one of our retirement professionals will be happy to help.

Also, was yours going from tIRA to Roth IRA?  That's a conversion, and Vanguard allows online conversion requests.  A recharacterization is Roth to traditional, with different required actions. 

By the way, they will move the amount plus any associated earnings or losses on those contributions. And that's happened to me before - I recharacterized $531 of my contribution one year, but because the IRA had lost money, only $513 was moved over.

Good point!  I've only done it where there are gains, but yes, losses are recharacterized as well.

[johnny847]

I've done exactly as the poster above described.  Just recaracterize the amount of your excess contribution as a non-deductible traditional IRA.

My IRA is with Vanguard. They require an actual signature to make the recaracterize, so it takes a few extra days for mail (so give yourself some extra time before the tax filing deadline). You tell them how much of your contribution you want to recaracterize and they will move that amount plus any earnings on those contributions, to a traditional IRA. Then just file your taxes as if you'd contributed the correct amount all along.

If you don't have other funds in a traditional IRA, you can then to a conversion back to a Roth (the back door method), and you are right back where you wanted to be.  (I haven't done that part.)

That's not true. On Wednesday I was able to recharacterize my tIRA contribution without sending in a form. This may be because I set up voice verification with Vanguard. I'm not sure.

I've never tried to do it over the phone, I just know it can't be done online.  Here's what the Vanguard website says:

How to initiate a recharacterization
Recharacterizations can't be completed online, so use this form to get started:
Download & print an IRA Recharacterization Form PDF
Or call us at 800-984-5931, and one of our retirement professionals will be happy to help.

Yup, calling is an option

Also, was yours going from tIRA to Roth IRA?  That's a conversion, and Vanguard allows online conversion requests.  A recharacterization is Roth to traditional, with different required actions. 

Money did move from my tIRA to my Roth IRA. However, you're mistaken. Recharacterizations can be done both ways. I contributed more money than I would have liked to my traditional IRA, and had that "undone" via recharacterization, and decided to have that money contributed to a Roth IRA instead.

Taken from https://www.irs.gov/instructions/i8606/ch01.html#d0e476

You made a contribution to a traditional IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a Roth IRA. If you recharacterized only part of the contribution, report the nondeductible traditional IRA portion of the remaining contribution, if any, on Form 8606, Part I. If you recharacterized the entire contribution, don’t report the contribution on Form 8606. In either case, attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2016, include the amount transferred from the traditional IRA on Form 1040, line 15a; Form 1040A, line 11a; or Form 1040NR, line 16a. If the recharacterization occurred in 2017, report the amount transferred only in the attached statement, and not on your 2016 or 2017 tax return.

Example. You are single, covered by an employer retirement plan, and you contributed $4,000 to a new traditional IRA on May 27, 2016. On February 24, 2017, you determine that your 2016 modified AGI will limit your traditional IRA deduction to $1,000. The value of your traditional IRA on that date is $4,400. You decide to recharacterize $3,000 of the traditional IRA contribution as a Roth IRA contribution, and have $3,300 ($3,000 contribution plus $300 related earnings) transferred from your traditional IRA to a Roth IRA in a trustee-to-trustee transfer. You deduct the $1,000 traditional IRA contribution on Form 1040. You don’t file Form 8606. You attach a statement to your return explaining the recharacterization. The statement indicates that you contributed $4,000 to a traditional IRA on May 27, 2016; recharacterized $3,000 of that contribution on February 24, 2017, by transferring $3,000 plus $300 of related earnings from your traditional IRA to a Roth IRA in a trustee-to-trustee transfer; and deducted the remaining traditional IRA contribution of $1,000 on Form 1040. You don’t report the $3,300 distribution from your traditional IRA on your 2016 Form 1040 because the distribution occurred in 2017. You don’t report the distribution on your 2017 Form 1040 because the recharacterization related to 2016 and was explained in an attachment to your 2016 return.

The contribution is being recharacterized. There's no conversion here.

[johnny847]

Oh yeah, if you want to be more confused, you can recharacterize a conversion =).

[Frugal716]

I just wanted to thank you all for the help. I went ahead and recharacterized the Roth contributions to a traditional (non-deductible) IRA, and will be converting it to a Roth soon.  I'll have some taxes due, but well worth it for the tax free Roth growth in the future.

Thanks again!