Figuring out earnings of excess roth contribution
Hello,
As 2009 comes to a close I unfortunately do not have enough earned income to cover my 2009 roth contribution. I have decided to do a full return of the excess contribution ($5000 for 2009).
This $5000 has appreciated considerably this year, and I am unsure how to calculate the amount of earnings that I need to remove along with this $5,000 contribution. I understand that I will need to pay the 10% penalty tax on the earnings of this $5000, but I do not know how to find out how much of my gains this year are attributable to the $5000 contribution of 2009. The problem is that in the same account I have my $5,000 contribution from 2008, and in the account I have done a fair amount of stock trading. When looking back on my trades I have no way of knowing which purchases were made with the $5000 from 2008 and which were made with the $5000 from 2009. Is there a formula I can use?
I called the IRS and studied PUB 590 but have not had a clear answer from either source. My Roth IRA account is worth about $17,000 and that is from a contribution of $10,000 (5000 this year and 5000 last year). As I said earlier, I do not have earned income this year as expected, so I need to remove the 2009 contribution.
In summary, I have about $7,000 in gains from stocks, but this has come from both my 2008 and 2009 contributions of $5000 each year. When I do my return of excess contribution, I am totally lost as to how to correctly figure out the gains that go with my 2009 contribution of 5000. The simplest way I can think of is to divide 7000 by two, but I know this is too simple and not accurate. And obviously the $7,000 gain in my account isn’t all from this year’s contribution.
The IRS basically said “do your best and error on the side of caution.” I can’t choose to pay the 6% excise tax and use next year’s earnings because next year I will be a full time student and probably won’t have any earnings again. I feel pretty overwhelmed and lost at what I should do.
Thank you for your help.
Permalink Submitted by Alan Spross on Tue, 2009-12-22 20:59
Glad you added the last paragraph as that would have been one of the useful options due to your gain.
There IS a formula that must be used, and it is fairly simple. Usually, the IRA custodian will calculate it because they have to know the exact balance as of the day the process the corrective distribution. Since you have a gain, the amount of the corrective distribution is ((closing balance/opening balance)) X 5,000.
For example, if the balance immediately after you made the 2009 contribution was 12,500 and when the distribution is processed it has increased to 17,000, the gain is 36%. 1.36 X 5,000 = 6,800. 1,800 would be taxable on line 15b and subject to 10% penalty. Note that none of the individual investments, trades or internal changes matter here. But if you took any other distributions or made any other contributions between the 2009 contribution and now, adjustments would have to be made for those. Either you or the custodian will have to come up with the opening balance info. If no daily records are available, use the month end statement figure.
Too bad you can’t retain all the gains in your Roth, but you will retain some of them there.
Here is the full explanation including calculating just the earnings figure rather than the full distribution per above, but otherwise should match up with above:
http://www.retirementdictionary.com/definitions/netincomeattributablenia
Permalink Submitted by Rick T on Wed, 2009-12-23 01:57
Thanks a ton for that help!! Does it seem strange that when I called the IRS they didn’t know about this formula?
So I looked up my account information, and on January 5, the day I contributed the $5,000 for 2009, my account was worth $11,096. after the deposit went through. As of the close of the markets today, the account was worth $17,235.67. Using the formula, the gain is 55% so I take 1.5533 * 5000 and come up with $7766.55, which means I need to remove that much and then pay a 10% tax on excess earnings of 2766.55. Did I do that right?
Since that contribution on Jan 5 2009 I have not taken any distributions or made and more contributions.
Once again, thanks so much.
Permalink Submitted by Alan Spross on Wed, 2009-12-23 04:36
Perhaps you did not get to the right IRS reps, but they should at least be able to connect you with the correct reference points. Yes, you did the calculations exactly right and could provide your documentation to the IRA custodian. However, remember that the custodian should use the closing balance when they actually process the distribution order, so they may want to adjust the closing balance. It should not make much of a dollar difference unless some market catastrophe takes place in the small time interval.
The IRS actually has a specific Reg for this in the link following, but the Retirement Dictionary reference is more user friendly.
http://www.taxalmanac.org/index.php/Treasury_Regulations%2C_Subchapter_A…
Permalink Submitted by Rick T on Wed, 2009-12-23 04:50
Well great, thanks a lot for those references. My IRA custodian didn’t seem to want anything to do with figuring out the amount and basically said I need to figure it out, but I will tell them to use the closing price at the time of the distribution and see what they say.
It is a shame I can’t keep these gains in the Roth, especially since I’m 24, and I know they could go a long way 🙁 But I’ve exhausted just about every possibility, and when it comes down to it I have no earned income this year, and I probably won’t for many years to come as I head back to school.
The only good thing I found is that on form 5329 I can use exception code 05 on line 2 to offset the 10% penalty tax. I have medical expenses around 300-400 this year, and since my earned income is $0, 7.5% of that is still 0, so I can use my medical expenses to soften the penalty a bit.
Alan, thanks so much for your help. You are always so quick and thorough with your answers, and I know that many other people (myself included!) really appreciate it. Have a merry Christmas!
-Rick