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Short version: Is there any good reason to contribute to a traditional IRA if I can't deduct the contribution this year?

Long version:
For about 15 years now, every year when I could afford it, I maxed out my Roth IRA. Until now, I never even knew that contributions to Roth IRAs were disallowed for people earning too much money. My salary isn't anywhere near close enough for that to be an issue.

I was able to max out my Roth contribution in 2020.

But my 2020 investment returns were miraculous, and my H&R Block software told me I'm not allowed to contribute to a Roth IRA.

No problem: It's still before April 15, so I figure I'll just withdraw that money and put it in traditional IRA.

Now my tax software is telling me I'm not allowed to deduct my contribution to a traditional IRA. (In reading the IRS website, I think the reason is a combination of high income + being covered by a 401K at work.)

So, my question is this: If I can't deduct it, is there any reason to contribute at all? Maybe I should just invest it in a non-retirement account?

I suppose this is more of an investing question than a tax question, but either way, I'd appreciate advice.
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Do you have an existing Traditional IRA in addition to your ROTH IRA. If you don't then you can contribute to a non-deductible TIRA and immediately convert it to a ROTH with no additional income taxes.
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I would consider withdrawing it and buying stocks in a regular brokerage account that has minimal tax consequences,such as
Berkshire-Hathaway.

When we retired,we had investments in roth,ira,and taxable accounts. Strangely more in the roths than the others.A couple of great investments in the roth.
The advantage of being able to pull from 3 different buckets really has paid off with tax planning.


JK
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Do you have an existing Traditional IRA in addition to your ROTH IRA. If you don't then you can contribute to a non-deductible TIRA and immediately convert it to a ROTH with no additional income taxes.

I like the suggestion. But doesn't the Roth IRA -> non-deductible TIRA recharacterization event cause problems with an immediate conversion back to Roth IRA event?
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Do you have an existing Traditional IRA in addition to your ROTH IRA ?

Does it need to be an old TIRA, or can I use a new one?

When I discovered I had to withdraw our Roth contributions, I opened a two new TIRAs (for me and my wife). My plan was (is?) to just move the money from the existing two Roths to the two new TIRAs.

If you're right, then I can essentially get what I originally wanted: for that money to be in Roth IRAs. Would I need to wait until after April 15, or after December 31?

Note: I don't know if this is relevant, but I expect 2020 was an anomaly in terms of my income bump. I expect to be well under the limit for Roth contributions when I'm doing my 2021 taxes next year.
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But doesn't the Roth IRA -> non-deductible TIRA recharacterization event cause problems with an immediate conversion back to Roth IRA event?

I had thought that, so long as I took that money out of our Roth accounts before April 15, it's as if it never happened. After all, I could just take that money out of our Roths and stick it in a passbook savings account, if I were so inclined.

(The Roth account is about 15 years old; I'm not taking out all my contributions, just the contributions I made in 2020 for the 2020 tax year.)
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I had thought that, so long as I took that money out of our Roth accounts before April 15, it's as if it never happened. - stevenjklein

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You should get your Roth Custodian involved in this reversal. Since they do the reporting to Uncle Sugar you want to be sure they report the re-characterization correctly. If you just do what looks like a run of the mill withdrawal, they may not relate that to undoing your Roth Contribution.

And speaking from experience, I just had to do this myself because of a spike income, you must also withdraw the earnings on that contribution which will then become taxable income to you. You need your custodian to calculate that earnings amount as the methodology for that calculation was not what I expected.
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Do you have an existing Traditional IRA in addition to your ROTH IRA ?

Does it need to be an old TIRA, or can I use a new one?

When I discovered I had to withdraw our Roth contributions, I opened a two new TIRAs (for me and my wife). My plan was (is?) to just move the money from the existing two Roths to the two new TIRAs.


When converting a TIRA to a ROTH, the tax basis is pro-rated across the value of all of your TIRAs. If you don't have any existing TIRA balances then the basis is used for the conversion.

The issue is not whether it is a new or old TIRA. The question is the existing balance in TIRAs.

You can recharacterize a ROTH over contribution. It is no longer possible to recharacterize a ROTH conversion.
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You should get your Roth Custodian involved in this reversal…

Thanks. I neglected to mention this, but I already filled out their "Removal-of-Excess Form," which includes a checkbox to have them calculate earnings.
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The issue is not whether it is a new or old TIRA. The question is the existing balance in TIRAs.

I have a rollover IRA with an existing balance, about $40K. I've had it long enough that I no longer remember where it came from, but probably a 401K plan from a former employer.

You can recharacterize a ROTH over contribution. It is no longer possible to recharacterize a ROTH conversion.

Sorry, but I don't understand that sentence. Can you put it more simply?
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You can recharacterize a ROTH over contribution. It is no longer possible to recharacterize a ROTH conversion.

Sorry, but I don't understand that sentence. Can you put it more simply?


It is possible to change an over contribution to a ROTH IRA to a TIRA contribution.

It is no longer possible to reverse a ROTH conversion. Previously, it had been possible to reverse a ROTH conversion. When the stock market dropped, a do-over was possible to reduce the income taxes.
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I had thought that, so long as I took that money out of our Roth accounts before April 15, it's as if it never happened.

Not exactly. You also need to take out the earnings, which are subject to taxes and penalties. As already suggested, you need to get the IRA custodian involved to get the correct earnings
amount calculated, since it's based on the overall earnings of the account since the contribution was credited.

If you recharacterize to a non-deductible Traditional IRA instead, you will avoid immediate taxes and any penalties. If you choose to convert that T-IRA back into your Roth IRA, you will be charged taxes on the earnings. However, this conversion doesn't work as well if you already have other T-IRA funds.

After all, I could just take that money out of our Roths and stick it in a passbook savings account, if I were so inclined.

Taking the money out without specifically saying that you are withdrawing an excess contribution doesn't avoid the fact that you made an excess contribution. You will be charged an excise tax of 6% on the excess contribution.

If you haven't already withdrawn the money, you have a few choices:
- You can leave the money in the account and pay the 6% excise tax on the excess contribution for 2020, and then apply the money to your 2021 contribution - since you are sure you'll be eligible in 2021
- You can remove the excess contribution and the earnings on the contribution - pro-rated over the total value of the account. You will be subject to taxes and penalties on the earnings in 2021.
- You can recharacterize the contribution into a non-deductible T-IRA contribution. What you do with it after that depends on whether you have other T-IRA accounts.

If you've already taken the contribution amount out, but didn't have the custodian send you both the contribution and earnings, then you need to call the custodian and see what they suggest. There are a few different ways that it could be handled, but you will still probably have to withdraw more to get the contributions out, too.

AJ
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I have a rollover IRA with an existing balance, about $40K. I've had it long enough that I no longer remember where it came from, but probably a 401K plan from a former employer.

Not sure if you made a $6,000 contribution or a $7,000 contribution, but let's assume that it's $6,000, and you had $600 in earnings on the $6,000. If you recharacterize the $6,600 (contribution plus earnings) into a T-IRA, you will have $46,600 in T-IRA total balances, with a $6,000 basis (taxes already paid). Note that $6,000 is 12.88% of $46,600, so 12.88% of your account has already been taxed and 87.12% is still untaxed.

If you do any Roth conversions, the taxable amount will be pro-rated across all of your T-IRA balances, even if you open a separate T-IRA for the recharacterized contribution and earnings and just convert that account. So if you convert the $6,600 that you recharacterized, $850 of the conversion (12.88% of $6,600) will not be taxed, and $5,750 (87.12% of the $6,600) will be taxable. Your remaining T-IRA of $40,000 will have a basis of $5,150. Whenever you withdraw money from your TIRA, be it to do a conversion or just to take money out, you will need to account for that basis, so you won't be taxed on the entire amount of the withdrawal.

You can recharacterize a ROTH over contribution. It is no longer possible to recharacterize a ROTH conversion.

Sorry, but I don't understand that sentence. Can you put it more simply?


Not without making the explanation a lot more wordy, which you still may not find simple:

Prior to the TCJA, you could recharacterize a conversion from a T-IRA to a Roth. This was useful for people who wanted to convert up to the tippy-top of a tax bracket, and not one penny more, but who also didn't know exactly what their income would be. They could do a conversion that they knew would put them over the top of a bracket and into the next bracket. Then, after they did an initial run at their taxes and knew exactly what their income was, they could recharacterize the amount that was over the top of the bracket that they wanted to be in, and not have to pay taxes on that amount.

The TCJA takes away that loophole by not allowing conversions to a Roth account to be recharacterized. However, you are still allowed to recharacterize an initial Roth IRA contribution and change it into a T-IRA. Whether or not the contribution is deductible or non-deductible is dependent on your income, filing status and whether you have a workplace retirement plan.

AJ
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Thanks, AJ, for all your help. I'm replying here to your most recent 2 messages in this thread.

First, we're old enough to contribute $7K.

Let me start by saying I found out that I couldn't use Roth when I saw this message from my H&R Block tax software:

"You can make a maximum contribution of up to $0 to a Roth IRA in 2020. The $7,000 you contributed that exceeds this maximum is considered to be an excess contribution and is subject to a penalty.

You can avoid the penalty if you can take these steps by the filing deadline:

1. Withdraw the $7,000 of excess contribution by April 15, 2021 (or extension date).
2. Re-enter your Roth IRA contribution or excess contribution amount, subtracting the excess contributions you withdrew.
3. Withdraw any income earned on the amount you withdrew."

At that point, I set aside the software and contacted TD Ameritrade (where our Roth IRAs are) so that I could move the money to a pair of new T-IRAs.

You also need to take out the earnings, which are subject to taxes and penalties.

I filled out TD Ameritrade's Removal-of-Excess Form, which notes that "the excess is being removed prior to the tax-filing deadline, including extensions. Earnings on your deposit will be calculated and removed.

Fine,right? Now the money will go into a T-IRA. Then I go back to my tax software and continue where I left off. I change my previous Roth contribution to a T-IRA contribution, and see this:

"Steven & wife can't deduct traditional IRA contributions." Huh? Why the hell not? Well, it turns out that because:
* I have a 401K from my job, and
* we're married filing jointly, and
* Our modified AGI is $124,000 or more
then contributions aren't deductible!

But if I understand the rest of what you wrote, when I start withdrawing from my various IRAs, I won't have to pay tax on that $7K (since I've already paid taxes on it.) Assuming earnings on that 7K were 700, my new T-IRA balance will be $47.7K, with a $7K basis. 7 ÷ 47.7 = 14.68%

Now if I recharacterize 7.7K (or any amount?), it's treated as being from the pooled value of all my T-IRA money, and the amount recharacterized will be considered to be 14.68% already taxed, 85.32% untaxed? And my T-IRA, even though it will have the same $40K as before, will now have a basis of 14.68 × 40K = $5872?

I'm guessing this confusing state of affairs is what you meant when you wrote, "However, this conversion doesn't work as well if you already have other T-IRA funds." Because now I have extra bookkeeping to do to make sure I know how much of my future T-IRA withdrawals are taxable. Otherwise, the math is easy, because they'd be 100% taxable.

But wait, , even if I don't recharacterize, then I'm still putting $7K of already-taxed money into my T-IRA. So I still have to keep track, right? Surely they won't make me pay tax on that $7K again when I withdraw?
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Now if I recharacterize 7.7K (or any amount?), it's treated as being from the pooled value of all my T-IRA money, and the amount recharacterized will be considered to be 14.68% already taxed, 85.32% untaxed? And my T-IRA, even though it will have the same $40K as before, will now have a basis of 14.68 × 40K = $5872?

On your TIRA, yes. It's called the pro-rata rule.

Note that if your wife doesn't have a TIRA with pre-tax money in it, her TIRA can just be converted in whole, and only the $700 in earnings will be taxed. Note that the taxes will be levied in 2021 - the year that the recharacterized IRA is converted. Since you expect your income to be back to your normal lower level, it shouldn't be as much as you

One way to avoid this is to roll all of your TIRA with the pre-tax money into your current employer's 401(k), thus emptying out your current 401(k). If you want, you can even roll the $700 in earnings from your current recharacterization into the 401(k), since that's pre-tax, too. Then you will be left with a TIRA of $7,000 that has a basis of $7,000, and you can convert that back into a Roth without paying any taxes.

I'm guessing this confusing state of affairs is what you meant when you wrote, "However, this conversion doesn't work as well if you already have other T-IRA funds." Because now I have extra bookkeeping to do to make sure I know how much of my future T-IRA withdrawals are taxable. Otherwise, the math is easy, because they'd be 100% taxable.

Correct.

But wait, , even if I don't recharacterize, then I'm still putting $7K of already-taxed money into my T-IRA. So I still have to keep track, right? Surely they won't make me pay tax on that $7K again when I withdraw?

Again, correct. Assuming that you don't want to pay taxes on the $7k, each year, you will have to account for what percent of your withdrawal is that after-tax amount. You will do so by using a Form 8606.

AJ
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But wait, , even if I don't recharacterize, then I'm still putting $7K of already-taxed money into my T-IRA. So I still have to keep track, right? Surely they won't make me pay tax on that $7K again when I withdraw?

Your tax return will need to include a form 8606 which documents your TIRA tax basis. When you take a distribution or conversion, the cost basis will be pro-rated across the value of your TIRAs (calculated for the individual not couple).
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AJ, check your email.
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Hi AJ.

Please check your email again.
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