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Tax woes... Excess Roth; how to fix it?

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FireAnt:
I'm new around these parts, and recently posted my case study (https://forum.mrmoneymustache.com/case-studies/case-study-social-worker-that-is-bad-at-math-but-wants-to-fire/) which brought up a huge problem with taxes. I'm thankful it was brought to my attention, yet now have a major headache from the mess this has caused.

Short recap: We are married filing separately (only in 2017) due to my student loan repayment plan. We have been contributing $350/month to a Roth IRA through Edward Jones. Someone on the thread brought up that there are limits to contributing it when the filing status is married filing separately. I looked into this and verified it's true. Now what to do? There are 3 parts to this I'm seeking input for:

1: 2017 money-- I can be penalized 6% for this. I can't change it anymore because the deadline was October 16. I can leave it and hope that I don't get flagged/audited. I don't know exactly how I would be able to pay the penalty ahead of time. (Hey IRS--- here's my money....) Anything that can be done or just leave it as is?

2: The 2018 already contributed money ($3500) -- I was offered the option of taking it out and putting it towards my car loan (approximately $13000 left at 4.57% interest, paying $1000/month towards it already). OR I can do a backdoor Roth under my husbands name. My understanding is that it would go to a non-deductible IRA and then transfer to a Roth. I'm told there is a minimum of $5000 to do this so I would have to dip into my savings account to make up the different- not a problem. What is the best route to go? Is there another route?

3: Future contributions of money -- $350 from now on. I initially decided to divert this to my retirement account through work. The benefit being that it would lower my income and help my student loan payments. I was told by my employer today that I will NEVER be able to change the 6% I contribute to that plan, but they offer a "457 deferred compensation plan" through John Hancock as an alternative. Would this be a good idea to do? Should I just have it be deferred to my husband's retirement account even though he's seeking new employment opportunities? Or is there another options I'm not aware of?

What a mess! Thank you in advance.

seattlecyclone:

--- Quote from: italianant on October 19, 2018, 09:59:50 AM ---1: 2017 money-- I can be penalized 6% for this. I can't change it anymore because the deadline was October 16. I can leave it and hope that I don't get flagged/audited. I don't know exactly how I would be able to pay the penalty ahead of time. (Hey IRS--- here's my money....) Anything that can be done or just leave it as is?
--- End quote ---

Sounds like you owe the 6% on this and you know it. This tax is computed on Form 5329. The right thing to do in this situation is probably file an amended tax return for 2017 with this form included. You will likely owe a bit of interest and/or late fees on the amount you should have paid already.

Note that you will continue owing 6% every year until you correct the excess contribution. The two options for correcting it are to either remove the money that was contributed above the limit, or to contribute that much less than the limit this year.


--- Quote ---2: The 2018 already contributed money ($3500) -- I was offered the option of taking it out and putting it towards my car loan (approximately $13000 left at 4.57% interest, paying $1000/month towards it already). OR I can do a backdoor Roth under my husbands name. My understanding is that it would go to a non-deductible IRA and then transfer to a Roth. I'm told there is a minimum of $5000 to do this so I would have to dip into my savings account to make up the different- not a problem. What is the best route to go? Is there another route?
--- End quote ---

I'm confused. You said you were filing separately for 2017 only, so you should be able to make 2018 contributions, right? Although if you are, you might find it most straightforward to simply withdraw this year's contribution you made so far and let this year's limit cancel out last year's excess contribution.


--- Quote ---3: Future contributions of money -- $350 from now on. I initially decided to divert this to my retirement account through work. The benefit being that it would lower my income and help my student loan payments. I was told by my employer today that I will NEVER be able to change the 6% I contribute to that plan, but they offer a "457 deferred compensation plan" through John Hancock as an alternative. Would this be a good idea to do? Should I just have it be deferred to my husband's retirement account even though he's seeking new employment opportunities? Or is there another options I'm not aware of?
--- End quote ---

A 457 plan can be a great option for an early retiree because there is no 10% early withdrawal tax. If the fees in the plan are at all reasonable, this is definitely something to consider.

Regardless, get out of Edward Jones ASAP. They steal your money through unreasonable fees. Move your accounts to a low-cost provider such as Vanguard, Fidelity, or Schwab.

FireAnt:
Yes, I filled everything out to begin the transfer from EJ to Vanguard today. Vanguard advised us on the tax form- thank you for that information with the link provided. When I initally posted this I had no idea how to rectify the issue since the October 16 deadline past to amend our 2017 returns. We will eat the 6% penalty including whatever fees and plan to pursue E&O on the EJ adviser. He was also the one telling us not to say anything regarding the 2017 money. We will be filing MFS again in 2018 - hopefully it will be the last year then!

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