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Here's a question for you tax experts out there.

When doing my taxes for 2009 I found that I had hit the income limit where my Roth contribution is getting phased out. So there was an over-contribution of about $2000. I understand that one of my options is to pull this extra contribution out along with the gains made, to avoid paying the 6% penalty on the contribution.

However, the gains on this had been very good this year (thanks HG!) so rather than pull it and the gains out or recharacterize them to Traditional IRA, I'm choosing to just pay the 6% penalty on the over-contribution, and I understand that I can count the $2000 overpayment towards my 2010 IRA contributions.

Since that $2000 of my 2009 contributions will now be assigned to 2010, that means I only contributed around $3000 total to my IRA accounts for 2009.

Now, my question is this then: Can I make an additional $2000 conribution for 2009 to my *traditional* IRA before April 15th? I realize this won't be tax deductible, but it will at least still get the advantage of tax free growth.

Thanks in advance for any information.

--Pete
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When doing my taxes for 2009 I found that I had hit the income limit where my Roth contribution is getting phased out. So there was an over-contribution of about $2000. I understand that one of my options is to pull this extra contribution out along with the gains made, to avoid paying the 6% penalty on the contribution.

However, the gains on this had been very good this year (thanks HG!) so rather than pull it and the gains out or recharacterize them to Traditional IRA, I'm choosing to just pay the 6% penalty on the over-contribution, and I understand that I can count the $2000 overpayment towards my 2010 IRA contributions.


You make this sound like an opportunity. Having peeked ahead, maybe I can start helping you straighten things out in your mind if I remind you that this is a cost of your decision to leave the 2009 Roth excess contribution as it is. It reduces your allowable 2010 combined traditional and Roth contribution to $3,000.

Since that $2000 of my 2009 contributions will now be assigned to 2010, that means I only contributed around $3000 total to my IRA accounts for 2009.

Bzzz! No, you contributed $5,000 for 2009. Since you're leaving it alone even though it was excess with respect to Roth income limits it still counts against your 2009 $5,000 total. The excess also counts against your 2010 contribution limit if you don't want another excess contribution penalty for 2010. Thus, if you don't fix this the total you can contribute, Roth and traditional combined, for 2009/10 is $8,000. See Part IV of Form 5329.

Now a question. Will you be eligible to make Roth contributions of at least $2,000 in 2010? If not, you're going to be back in this same mess a year from now. It might be a good idea to recharacterize the excess and keep that $120 working for you rather than Uncle Sugar, plus you'd be able to make a full $5,000 conribution for 2010.

Phil
Rule Your Retirement Home Fool
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Hi Phil,
Thanks very much for the reply.

Bzzz! No, you contributed $5,000 for 2009. Since you're leaving it alone even though it was excess with respect to Roth income limits it still counts against your 2009 $5,000 total. The excess also counts against your 2010 contribution limit if you don't want another excess contribution penalty for 2010. Thus, if you don't fix this the total you can contribute, Roth and traditional combined, for 2009/10 is $8,000. See Part IV of Form 5329.

Okay, I see what you're saying but here's where I was coming from on this (please point out where I'm making a mistake here):
If I make another $2000 contribution to a traditional IRA, my 2009 contributions would be:
$5000 Roth IRA
$2000 Traditional IRA
This would mean the excess contribution would still be $2000, correct? So why couldn't I do this? My total contribution allowed for 2010 would then be $3000, still, would it not?

Now a question. Will you be eligible to make Roth contributions of at least $2,000 in 2010? If not, you're going to be back in this same mess a year from now. It might be a good idea to recharacterize the excess and keep that $120 working for you rather than Uncle Sugar, plus you'd be able to make a full $5,000 conribution for 2010.

Not sure. I'll probably be in about the same boat, so I figure I should be allowed at least $2000 Roth in 2010. But maybe not. It would be nice not to have to worry about it.
So, to recharacterize, you mean have my custodian transfer the excess contribution plus earnings to a traditional IRA? This would probably be a better option, but I have a couple more questions regarding this:
- I have a rollover IRA (from a 401k from an old employer) at the same custodian. Is a rollover IRA the same as a traditional IRA once its established? Can I just make the transfer to this account?

- To calculate the earnings, I've tried to find the calculation, but its seems to be based on the account value at the time of the contribution, and the account balance at the time of withdrawl. My contribution was made in regular $200 increments throughout the year. How are the earnings calculated?

- To make the transfer to traditional IRA, am I required to liquidate the holdings, or is transfer of stock allowed?

- How is this recharacterization reported on the tax return?

Thanks again, your help is much appreciated.

--Pete
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If I make another $2000 contribution to a traditional IRA, my 2009 contributions would be:
$5000 Roth IRA
$2000 Traditional IRA
This would mean the excess contribution would still be $2000, correct?


No. You'd now have an excess 2009 Roth contribution of $4,000. See Worksheet 2-2 on page 63 of Pub 590. Note that you first apply the income phaseout to the $5,000 limit, then subtract your traditional IRA contributions to reach your allowable Roth contribution.

My total contribution allowed for 2010 would then be $3000, still, would it not?

No, now you'd be down to $1,000 for 2010 and, likely, another Roth overcontribution since you started with $4,000.

Now a question. Will you be eligible to make Roth contributions of at least $2,000 in 2010? If not, you're going to be back in this same mess a year from now. It might be a good idea to recharacterize the excess and keep that $120 working for you rather than Uncle Sugar, plus you'd be able to make a full $5,000 conribution for 2010.

Not sure. I'll probably be in about the same boat, so I figure I should be allowed at least $2000 Roth in 2010. But maybe not. It would be nice not to have to worry about it.

So, to recharacterize, you mean have my custodian transfer the excess contribution plus earnings to a traditional IRA?


Yes.

This would probably be a better option, but I have a couple more questions regarding this:

- I have a rollover IRA (from a 401k from an old employer) at the same custodian. Is a rollover IRA the same as a traditional IRA once its established? Can I just make the transfer to this account?


Yes.

- To calculate the earnings, I've tried to find the calculation, but its seems to be based on the account value at the time of the contribution, and the account balance at the time of withdrawl. My contribution was made in regular $200 increments throughout the year. How are the earnings calculated?

Same process, just more calculations. But don't worry. Your custodian will calculate the earnings. You just have to tell them which contributions (the latest ones, I assume) you want recharacterized.

- To make the transfer to traditional IRA, am I required to liquidate the holdings, or is transfer of stock allowed?

Stock is fine.

- How is this recharacterization reported on the tax return?

See the instructions for Form 8606. You'll need to report the nondeductible traditional contribution (the result of the recharacterization) in Part I, and the instructions tell you what kind of statement to attach regarding the recharacterization.

Phil
Rule Your Retirement Home Fool
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Hi Phil,
Thank you and I really appreciate your responses.

No. You'd now have an excess 2009 Roth contribution of $4,000. See Worksheet 2-2 on page 63 of Pub 590. Note that you first apply the income phaseout to the $5,000 limit, then subtract your traditional IRA contributions to reach your allowable Roth contribution.

I'm still not satisfied on this point.
It was my understanding that the income limitation only applies to the Roth, not the traditional IRA. It should not affect the total amount that you can contribute to all of your IRA's. In other words even if you can contribute only $3000 to your roth, you can still contribute $5000 total to your IRA's for the year, so another $2000 should still be able to go to the traditional IRA without affecting the Roth overpayment.

Even the worksheet you pointed me to seems to support my understanding of it. Working through the example, if my Roth limit which is calculated first was $3000 on line 8, the following lines would be:
8. 3000 <== calculated reduced Roth IRA limit
9. 2000 <== contributions to other IRA's
10.3000 <== subtract line 9 from line 6 (the $5000 limit)
11.3000 <== lesser of 8 or 10 -> Final Roth contribution limit

So, this worksheet still allows for a total of $5000 to the IRA's for the year. So according to this, I'd have $2000 in traditional, and $3000 in Roth (and in my case another $2000 excess contribution over my Roth limit.)


Another way to illustrate it is to change the order of events:
Say that I had contributed first $2000 to a traditional IRA.
Then I contributed $3000 to a Roth IRA. All is fine at this point.
Then say I contributed another $2000 to the Roth.

Would you then say that I need to take the $2000 out of the traditional IRA? I don't think so. I think it is just a $2000 excess Roth contribution. Am I wrong?



But anyway... this may all be a moot point for my situation. I may just take your suggestion and do the recharacterization of the overpayment to a traditional IRA, and then all will be fine.

Thanks again for the help.

--Pete
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