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Author: malmalusa Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Roth and the wage limits again. Date: 1/13/1999 3:26 AM
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I opened a Roth IRA this year, everything fine...
However during 1999 my wife will be going back to
work and my part time business will contribute
an unknown amount to my income. Its quite possible
that come 2000 tax return time we will find ourselves
over the Roth contribution limit.
I would like to contribute my $2k to my Roth this
month to maximise my potential gains, but what happens
if in 12 months time if I find I'm over the contribution limit?
1) Can I convert my Roth contribution to a regular
IRA contribution.
2) What happens to any gain or loss that I make on the
$2k I invested, and if its relevant how would I
calculate the loss/gain given that the money will be
agrigated with my previous contributions?
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Author: piz Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8332 of 121061
Subject: Re: Roth and the wage limits again. Date: 1/13/1999 10:14 AM
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malmalusa wrote:
I opened a Roth IRA this year, everything fine. However during 1999 my wife will be going back to work and my part time business will contribute an unknown amount to my income. Its quite possible that come 2000 tax return time we will find ourselves over the Roth contribution limit.

I would like to contribute my $2k to my Roth this month to maximise my potential gains, but what happens if in 12 months time if I find I'm over the contribution limit?


First of all, if there is any reasonable chance that by the end of the year you will have exceeded one of the AGI limits (or met one of the other conditions that reduce or eliminate your allowable IRA contribution), it's probably safer and easier if you don't make your 1999 contribution until after 12/31/99.

I changed jobs in December and found myself a participant in an employer-sponsored retirement plan for the first time in years. However, that meant that with my 1998 AGI my traditional IRA contribution was eliminated, after I had already made most of it in the preceding months. I had to back out those contributions, plus the gains made on them (following the rules in IRS Pub. 590). Now I have to pay tax on the gains, treating them as income. I opened a Roth and put that money into it, since I can still make Roth contributions, but it was a real pain to go through the backing-out process.

From now on I will not make any IRA contributions until the tax year is over and I have determined what my contribution limit is. That means for this year I'll miss out on the potential gains I would have made if I had made my 1999 contribution now, but given the potential tax pain I could face if my situation changes again it's worth it.

Regarding your specific questions:

1) Can I convert my Roth contribution to a regular IRA contribution.

It's very easy to be eligible to make Roth contributions but not to make traditional IRA contributions. Be careful here - check your AGI and be aware of the other rules that limit or eliminate your contribution amount.

2) What happens to any gain or loss that I make on the $2k I invested, and if its relevant how would I calculate the loss/gain given that the money will be agrigated with my previous contributions?

This is more complex, but I've just been through it so I'll try to explain. The following discussion applies to backing out contributions to a traditional IRA - I believe that, because they've already been taxed, you can withdraw your contributions to a Roth at any time without having to report anything at all to the IRS. Roy will correct me if I'm wrong about that.

When you back out contributions, the actual amount of the contributions themselves are treated just as if you had never made them. In other words, if you contributed $2000 that you would then deduct on your tax return, you withdraw the $2000 from your IRA and don't deduct it. There is no penalty for making such a withdrawal as long as the contributions you withdraw are for the current tax year (the tax year for which you are filing your upcoming return).

The gains you made on those contributions are trickier. There is no procedure defined by the IRS for determining what those gains are. I was all over Pub. 590 looking for a procedure - it's not there. So here's what I did:

1. My contributions had been $166.67 on the 19th of each month (my birthday is Jan 19 :-) beginning in January and ending in August(a total of $1333.36).

2. For each contribution, I took the total value of my IRA (remember, it doesn't matter how many different IRA accounts you have at different institutions - the IRS considers them one big IRA so you have to add them all up to get the total value) as of the contribution date. With that number, I computed the gain on the entire IRA from that date up to the date I made the withdrawal. I applied that percentage gain to the contribution amount to determine what the gain was on just that much.

For example, using the $166.67 I contributed on Jan 19: Assume the total value of my IRA on that date was $50,000 (it wasn't really - this is an example, eh? :-). I made the withdrawal on 12/21/98, so let's say on that date the total value was $60,000, a gain of 20%. The gain on my January contribution was $166.67 * 20%, or $33.33.

I did the same for each contribution, getting a different gain amount for each of them. Adding all eight of those gain numbers together gave me a total gain on my contributions.

NOTE: Since there are no IRS-defined procedures for calculating the gain on your contributions, there is no way to determine if what I did was correct or not. I believe it's reasonable, and I hope the IRS believes the same. But they might disagree and tow my house away. If you can find a better answer than I did, great (and let me know what it is :-).

When you back out your contributions, that total gain amount must be withdrawn along with the contributions themselves according to the IRS rules. You pay tax on those gains as if they were income.

If your IRA lost money, I don't know what you would do. I'd probably just withdraw the contribution amount without subtracting any losses, just to be safe. Remember, the IRS has a habit of pouncing on gains but pretending losses don't exist.

As always, your mileage may vary. I'm not a tax professional, so this info may be totally bogus. Void where prohibited. Do not taunt Happy Fun Ball.

Piz

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Author: WilliamLipp Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8333 of 121061
Subject: Re: Roth and the wage limits again. Date: 1/13/1999 10:25 AM
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piz Date: 1/13/99 10:14 AM Number: 8332
It's very easy to be eligible to make Roth contributions but not to make traditional IRA contributions. Be careful here - check your AGI and be aware of the other rules that limit or eliminate your contribution amount.

I believe anybody with $2000 or more of income can contribute $2000 to a traditional IRA. I think you are warning that it may not be tax deductible. But the growth will still be tax deferred. I think it makes good sense even if you can't deduct it.

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Author: piz Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8335 of 121061
Subject: Re: Roth and the wage limits again. Date: 1/13/1999 10:39 AM
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WilliamLipp wrote:
piz Date: 1/13/99 10:14 AM Number: 8332
It's very easy to be eligible to make Roth contributions but not to make traditional IRA contributions. Be careful here - check your AGI and be aware of the other rules that limit or eliminate your contribution amount.

I believe anybody with $2000 or more of income can contribute $2000 to a traditional IRA. I think you are warning that it may not be tax deductible.


Yes. I should have put the word "deductible" in there:

It's very easy to be eligible to make Roth contributions but not to make deductible traditional IRA contributions.

But the growth will still be tax deferred. I think it makes good sense even if you can't deduct it.

Depends on your situation. If you're eligible to make Roth contributions that's better than making non-deductible contributions to a traditional IRA. If you're eligible for neither then I think your only option is the latter. Other variables come into play as well, but in the broadest sense I agree with you.

Piz

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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 8357 of 121061
Subject: Re: Roth and the wage limits again. Date: 1/13/1999 8:26 PM
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[[ I opened a Roth IRA this year, everything fine...]]

I assume that you mean that you made a Roth IRA contribution (not a conversion) in 1998. The words "this year" and "last year" tend to lose their meaning this time of year.

[[ However during 1999 my wife will be going back to
work and my part time business will contribute
an unknown amount to my income. Its quite possible
that come 2000 tax return time we will find ourselves
over the Roth contribution limit.]]

OK...

[[ I would like to contribute my $2k to my Roth this
month to maximise my potential gains, but what happens
if in 12 months time if I find I'm over the contribution limit?]]

You'll either have to recharacterize your Roth IRA back to a regular IRA (either deductible or non-deductible, depending upon your circumstances). Or you can close the Roth IRA account completely. You'll pay no tax or penalties on the original contribution, but you'll pay ordinary taxes and penalties on the EARNINGS that you made in the Roth IRA account.

[[ 1) Can I convert my Roth contribution to a regular
IRA contribution.]]

Yup...

[[ 2) What happens to any gain or loss that I make on the
$2k I invested,]]

If you converrt back to an IRA, absolutely nothing, either gain or loss. But if you close the account and take the distribution: If it's a loss, nothing. If it's a gain, you'll pay taxes and penalties on the distribution.

[[ and if its relevant how would I
calculate the loss/gain given that the money will be
agrigated with my previous contributions?]]

You'll have to do your best to "carve out" your second distribution and the gains on that specific distribution. Since the funds will be co-mingled, you'll most likely have to make some computations based upon the balance of the accounts at different dates, and then allocate the total earnings to each account. The IRS hasn't told us specifically how to do this (and most likely will not). They just say that the earnings on the account must be removed with the contribution.

You can read more about the recharacterization issue in my post on that issue in the Taxes FAQ area. You can also read more about the Roth IRA in my series of posts in the Taxes FAQ area (archives section). Check it out.

TMF Taxes
Roy

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