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I contributed the full $5,500 to my Roth IRA this year only to just realize that I am completely ineligible for it and therefore I now have an excess contribution of $5,500. The perils of being a newlywed... Anyway, now I am trying to figure out how to remedy it. Two options:

1) Withdraw it all. Pay 10% distribution penalty (but what is the 10% assessed on?). and pay 33% taxes on the net income attributable. In rough numbers my NIA is 5500 x ((60000-40000)/40000) = 2750. So "loss" = $900 + penalty. Note I live in FL but spent the first 8 months of 2013 in NY, so maybe state tax comes into play too?

2) Keep it there and don't contribute anything more this year (I have already contributed $750) I would pay 6% excise tax but only on the excess contribution. So $330 for 2013 excess and $45 for 2014 excess. Note that this is an option because my husband made a career switch and took a significant pay cut so I anticipate full eligibility again in 2014.

By my logic option #2 is the obvious way to go. But I want to make sure that all my assumptions are correct. Mainly I want to make sure the 6% excise tax does not apply to NIA. Please help! Thank you in advance!
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jettaker: "I contributed the full $5,500 to my Roth IRA this year only to just realize that I am completely ineligible for it and therefore I now have an excess contribution of $5,500. The perils of being a newlywed... Anyway, now I am trying to figure out how to remedy it. Two options:

1) Withdraw it all. Pay 10% distribution penalty (but what is the 10% assessed on?). and pay 33% taxes on the net income attributable. In rough numbers my NIA is 5500 x ((60000-40000)/40000) = 2750. So "loss" = $900 + penalty. Note I live in FL but spent the first 8 months of 2013 in NY, so maybe state tax comes into play too?

2) Keep it there and don't contribute anything more this year (I have already contributed $750) I would pay 6% excise tax but only on the excess contribution. So $330 for 2013 excess and $45 for 2014 excess. Note that this is an option because my husband made a career switch and took a significant pay cut so I anticipate full eligibility again in 2014.

By my logic option #2 is the obvious way to go. But I want to make sure that all my assumptions are correct. Mainly I want to make sure the 6% excise tax does not apply to NIA. Please help! Thank you in advance!"


The real Tax pros will likely be along, but I believe that there is a third option, to recharacterize the 2013 contributon as a traditional IRA contribution (though it will likely not be deductible).

No change in income tax due for 2013 because you were not deducting the Roth contribution anyway, no excise tax, no early withdrawal.

"Alternatively, an individual may recharacterize a Roth IRA contribution to a Traditional IRA contribution in order to claim a tax deduction for the amount, or because he or she is ineligible for the Roth IRA contribution."

http://www.investopedia.com/articles/retirement/03/092403.as...

Only potential downside, you create basis in a traditional IRA, and if you currently have no traditional IRAs with basis, potential complicate the tax calculations of any future traditional to Roth IRA conversions because you must allocate basis across all traditional IRAs when converting some portion of your Traditional IRAs.

Regards, JAFO
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1.) The contribution part of a correcting distribution is not taxed or penalized when the overcontribution is corrected promptly.

The IRA administrator would calculate the actual required distribution amount. Since taxes and penalties only apply to the income associated with the over contribution, it would be a minor amount.


3.) The previous post covered the option of recharaterizing the contribution to an after-tax TIRA. A form 8606 would need to be filed to establish your cost basis.
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Yes. That would be an option too. I do not currently have a traditional IRA so I would open one to roll the excess into it. Would I only need to put the $5,500 in there or do I also need to transfer NIA? At some point in the future I'm sure I will once again not be eligible for Roth so I am not adverse to opening the account. Whatever results in the least taxes/penalties!
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What is NIA?
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jettaker: "Yes. That would be an option too. I do not currently have a traditional IRA so I would open one to roll the excess into it."

Words really matter here. "Rollover" and "Recharacterization" are terms of art and mean two very different things.

You are not rolling over anything; you are recharacterizing your 2013 contribution!

"Would I only need to put the $5,500 in there or do I also need to transfer NIA?"

You are still confusing a rollover and a recharacterization.

You should be able to to this with your Roth custodian very easily.

See e.g.:

http://www.investopedia.com/articles/retirement/03/092403.as... from which I quited in my prior post

"Some financial institutions will process the recharacterization by simply changing the IRA from one type to another. Check with your IRA custodian/trustee about their procedure and any documentation requirements for processing a recharacterization." Id.

"For tax purposes, the [recharacerized contribution amount] will be treated as though it were made to the [traditional] IRA from the beginning."


https://personal.vanguard.com/us/insights/taxcenter/rothira-...
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Here's what I think are the facts:

You have no traditional IRA of any type, including SEP, SIMPLE, and rollovers from prior employer plans. Your 2013 joint income bars the Roth contribution you already made.

I think your best course is:

1. Recharacterize the 2013 contribution to be a traditional IRA contribution.

2. Report this nondeductible contribution on Form 8606 on your 2012 return.

Your deadline for this action is Oct 15, 2014. There is zero tax or penalty.

Once you've established the traditional IRA via the recharacterization convert the traditional IRA to Roth. Only fhe earnings will be taxable. This is a 2014 transaction.

Phil
Rule Your Retirement home Fool
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Exactly when did you make the contribution ?
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2. Report this nondeductible contribution on Form 8606 on your 2012 return.

2012?
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2013.

Thanks for the catch.

Phil
Rule Your Retirement Home Fool
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