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Author: crackdclaw Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121594  
Subject: Roth contribution above income Date: 11/27/2012 12:45 PM
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A work colleague mentioned today that he will be making a contribution to his Roth IRA soon for 2012. As I'm aware his 2012 income exceeds the maximum income limit, (single, well over $125k) I asked why/how he was going to do this?

He replied he was not aware of the income limits and had openened the Roth account 6 years back and had made contributions each year. We discussed his income over the past six years and in the year he opened the account he was eligible, but 4 of the following 5 years his income exceeded the amount where a Roth IRA contribution was permissable.

Is there any check or balance within the IRS to notice? Any possible penalty in the future? His stance was that even though he now knows it's not permissable, since he is not taking a deduction against current income and he hasn't received any notice not to do this, he will continue to fund his Roth each year as a retirement vehicle.

Not judging, but I don't think this is a good strategy for him and would like to provide additional information on risks he may be taking. He's young, early 30's, and thinks when goes to take this money out in 30+ years, no one will notice. The gains in the account over the years are minimal, maybe $2,500., which would allow him to "get legit" without too much of a penalty. Anybody have ideas on how he is able to do this without notice and what risks / penalities he may be incurring?
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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 116998 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 2:47 PM
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He's young, early 30's, and thinks when goes to take this money out in 30+ years, no one will notice. The gains in the account over the years are minimal, maybe $2,500., which would allow him to "get legit" without too much of a penalty. Anybody have ideas on how he is able to do this without notice and what risks / penalities he may be incurring?

Oh dear, where to begin?

Although we call it a penalty for excess contributions, it's actually an excise tax reported on Form 5329 and usually added to the 1040. However, it's a standalone tax. No 5329, no start of the running of the statute of limitations. IOW, when they get around to it the IRS can go back as far as they like.

When, indeed, might they get around to it? At they moment they're fishing in deeper waters--failure to take Required Minimum Distributions (RMD's) from traditional IRAs. That one's 50% of the RMD, thus more bang for the buck. I would think that when that well runs dry they might move on to excess Roth contributions. The penalty there is 6% of the excess for the year of contribution and, in your friend's case, probably an additional 6% for every year he leaves it there. Earnings have absolutely nothing to do with it, and they already have all the information they need (income from the return and contribution amount from the 5398 filed with them by the custodian).

You can disabuse your colleague of his misunderstanding of how the penalty works with a copy of Pub 590. If he'd like to fix things we can advise you how he goes about doing it. It doesn't sound like he's really interested in doing that since he thinks he'll never get caught. You may be able to entice him by telling him that there could be a way for him to make perfectly legal Roth contributions going forward. No way would I tell him about until until he, as we say in Kansas, gits right with the Lord.

Phil
Rule Your Retirement Home Fool

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Author: Watty56 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117003 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 5:22 PM
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His "income" and the "Modified adjusted gross income(MAGI)" that is used for figuring out the Roth eligibility may be very different.

He should check it out to find out the details of just what is excluded from the MAGI but it could have been reduced a lot by things like 401k contributions, flexible spending accounts, some pre-tax payroll deductions like for health care, etc.

If he did his tax with tax software I would be surprised if he able to do the Roth contribution if he was not eligible without at least getting a big warning that he would have to override.

Greg

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117005 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 5:30 PM
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If he did his tax with tax software I would be surprised if he able to do the Roth contribution if he was not eligible without at least getting a big warning that he would have to override.

Roth contributions aren't reported anywhere on the return unless you claim the Retirement Saver's Credit, which he wouldn't qualify for because it phases out for single filers at a ridiculously low AGI. If I already know I can't make the contribution because of my income level, why tell software?

Phil
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Author: crackdclaw Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117006 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 6:25 PM
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they already have all the information they need (income from the return and contribution amount from the 5398 filed with them by the custodian).

Phil, Thanks for the info and the reference to Pub 590. What you said above I'll pass along. The idea that their is no statue of limitations, and all the data resides with the governing agency, that should indeed be enough to warn him away from this future tax dodge.

You may be able to entice him by telling him that there could be a way for him to make perfectly legal Roth contributions going forward.

If the availablity of this is possible without reducing current earned (W2) income, would love to know for myself how to make Roth IRA contributions when you exceed income maximums.

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Author: ferjen Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117007 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 6:55 PM
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If the availablity of this is possible without reducing current earned (W2) income, would love to know for myself how to make Roth IRA contributions when you exceed income maximums.

I'm pretty sure if you don't have a Traditional IRA, start one, fund it, and immediately convert it to a Roth. That's how...

But if you have any other Traditional IRA's, I think you'd have to convert all of those, too...

In our case, we had no Traditional IRA's when we converted, so we funded brand new ones and converted tax free. Well, almost tax free. In the time it took to convert, we had 2 cents in interest on each account. So, I guess we have to pay tax on the 4 cent total... :-)

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Author: vkg Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117008 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 7:29 PM
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If I already know I can't make the contribution because of my income level, why tell software?

The claim is he didn't know.

Tax software normally asks, so that it can tell you if a ROTH contribution is not allowed or that your combined contribution to TIRA & ROTH is over the contribution limit.

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117009 of 121594
Subject: Re: Roth contribution above income Date: 11/27/2012 7:45 PM
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You may be able to entice him by telling him that there could be a way for him to make perfectly legal Roth contributions going forward.

If the availablity of this is possible without reducing current earned (W2) income, would love to know for myself how to make Roth IRA contributions when you exceed income maximums.


It's more or less as ferjen said. If you have no traditional IRA account, including SEPs, SIMPLEs, and rollovers from prior employer plans, you can make a nondeductible contribution and immediately convert it to Roth with no current tax effect. If you do have pre-tax money in any traditional IRA account each distribution, including conversions to Roth, is a proportional mix of taxable pre-tax and nontaxable post-tax money.

Phil
Rule Your Retirement Home Fool

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Author: ferjen Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117028 of 121594
Subject: Re: Roth contribution above income Date: 12/1/2012 10:05 AM
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We'd like to do the Roth conversion again next year, but I never thought about the fiscal cliff and the possibility of that loophole being closed. Need to look into that...

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 117029 of 121594
Subject: Re: Roth contribution above income Date: 12/1/2012 10:14 AM
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We'd like to do the Roth conversion again next year, but I never thought about the fiscal cliff and the possibility of that loophole being closed.

Unlike most of the changes made in the aughts, this one has no sunset, so "the cliff" is irrelevant.

Phil
Rule Your Retirement Home Fool

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