Excess Contribution to Roth IRA

Submitted by Mark Taylor on Wed, 2008-03-26 00:45

I just found out that our AGI for 2007 was too high for us to contribute to a Roth IRA. I am told I can either recharactize or take an excess contribution for 2007. I have already filed our tax return for 2007 (our accountant did not address any of this which is a major concern and frustration), and we could not deduct the conts. if we recharacterize to a TIRA. Where do I go from here ?



Submitted by Alan Spross on Wed, 2008-03-26 01:28

Your accountant should have asked whether you made an IRA contribution and the amount and type, so the information could be captured by his tax software. If your were asked this information, then his failure to respond could actually mean that you may not really have an excess contribution.

But IF you do, here are your choices now:
1) Leave the excess amount in there. You can file a stand alone 5329 after the tax season and pay a 6% excise tax on the amount of excess. In that case, you would not have to amend your return and any earnings from the excess contribution could stay in the Roth IRA. You can then apply the excess amount to your 2008 contribution on a 5329 with your 2008 return, and there will be no further tax or penalty. To do this you must be eligible for a 2008 contribution. This solution has further advantages if you have had good earnings on the excess contribution, but that’s less likely now with down markets.

2) Correct the excess contribution no later than end of September, and then amend your return to include the income and penalty on the earnings.

3) Recharacterize the contribution from a Roth to a TIRA contribution by asking the custodian to change it. Since you will apparently not be able to deduct the contribution, you would then file an 8606 to report the added basis to each of your traditional IRAs. This would prevent double taxation in the future. Each of you would file an 8606, but this could be done on a stand alone basis without an amended return. Any earnings on the excess just transfer over to the TIRA account.

You could probably do either 1 or 3 on your own without going back to the preparer. #2 requires a 1040X and is therefore more complex.

Note that if your joint modified AGI is under 156,000 and one spouse does not participate in a retirement plan at work, that spouse may be able to deduct the TIRA contribution. While that’s good, it would require an amended return to take that deduction.

In summary
1) you can do this totally on your own if you can file the 5329
2) requires IRA custodian request and a 1040X (accountant)
3) requires IRA custodian request plus you can likely do the 8606 forms yourself.

Actually, the accountant should file the 1040 X without charge since the failure to get the IRA info or apply it is his professional responsibility. But you have to juggle all the variables to determine what is best for you.



Submitted by Mark Taylor on Wed, 2008-03-26 15:46

Alan, thank you so much for the detailed information. I appreciate it very much. If it turns out that I cannot contribute to a Roth and also cannot deduct a TIRA, is there any benefit to putting money into a TIRA for 2008 instead of just a standard mutual fund ?



Submitted by Alan Spross on Thu, 2008-03-27 00:37

The is not a large trade off between a non deductible TIRA contribution and simply making a tax efficient investment in a taxable account. Any small advantage of the taxable account depends on survival of the current low rates on LT cap gains and qualified dividends that is set to expire after 2010. There is good chance of those rates increasing or at least the rates for those in the 25% or higher tax brackets.

The non deductible TIRA contribution could provide funds to convert to a Roth starting in 2010 when the income limits disappear and everyone will be able to convert. So this may be a better solution, as it can lead to Roth assets indirectly by doing the Roth conversion after 2009. You just have to wait two years to get the funds into the Roth.



Submitted by Mark Taylor on Thu, 2008-03-27 15:54

Thanks again for your help. It seems that doing the TIRA for a couple of years and seeing what happens in 2010 at least is worthwhile.



Submitted by Mark Taylor on Wed, 2008-05-21 16:54

I am thinking I want to go ahead and recharactierize the excess 2007 Roth contribution into a TIRA. I have a rollover IRA from a previous 401K plan that I created in 1999 when I left a former company. Can I put the recharacterized money into that IRA or will that make things very complicated ? The accountant I have previously used has not been very helpful and says this is a very complicated thing to keep track of and I should not do it but the people at Vanguard say it is very easy. I have never filed a Form 8606 before. When I fill in line 2, Total basis, do I put in $0 or do I have to put in the amount of the rollover IRA ? I am wondering if it would be easier just to set up a new account for the 07 recharacterization and then add 08 and 09 non deductible TIRA contributions as well and then covert to a Roth in 2010.

As always, thanks for your help.



Submitted by Alan Spross on Wed, 2008-05-21 22:31

You can recharacterize the funds into any TIRA you wish, but remember that it must be done by direct transfer only, and also that it is irrevocable once done.

If you cannot deduct the contribution, then you must include an 8606 to report the basis in the TIRA on your amended return if you opt to do one . While you might be able to avoid an amended return as I indicated before, the IRS still wants an explantory statement describing the contributon and recharacterization amounts and dates, and the 1040X is an ideal place to enter that explanation. But this will only change your tax bill if you can deduct some or all of the contribution, so the 1040 X should be very easy to do.

Since this is your first 8606, you would enter the amount of the original contribution on lines 1, 3 and 14. Line 2 would be -0-. That’s all there is to it. Each of you needs an 8606 since those are individual like the IRA itself. Since all your TIRAs are considered as one, the 8606 applies to the total basis in all the accounts. That’s why it does not matter which account you recharacterize to or which account you make your regular contributions to in the future. Your conversion reporting later on would not change because the 8606 represents totals for all the TIRAs of each spouse, one 8606 for each spouse NOT each account.



Submitted by Mark Taylor on Wed, 2008-05-21 23:06

Thanks Alan. I will file an 8606 form for my wife and one for myself, plus one 1040X. Since none of the contributions are deductible it seems none of the amounts on the original 1040 change so I can just skip all of the questions on the 1040X and put an explanation in Section 2.

It seems my now former accountant is unwilling to help me correct his mistake so I am on my own right now. Your guidance is invaluable.

Thanks Again,

Mark



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