Roth funded by mistake
If a client funded a roth ira by mistake since 2006, can’t he just somehow convert the money into an trad-ira so he doesn’t have to pay all the excise tax from funding the roth over the years?
or
is there any other way to not have to pay the excise tax? (he put in approx. 26k and now its worth 50k and they say he owes almost 12k in taxes)
thank you,
Douglas
Permalink Submitted by Alan - IRA critic on Tue, 2017-05-23 16:31
If client has taken no distributions since 2006 or if client was not eligible for a Roth contribution in any of those years, he does owe the excise tax for the total balance of excess contributions at the end of each year plus interest if the IRS bills late interest. There is no statute of limitations for excess IRA contributions. Client can still recharacterize his 2016 Roth contribution as a TIRA contribution or have it returned with allocated earnings. For any 2006-2015 excess Roth contributions, he should withdraw the total amount before year end. The earnings can remain in the Roth.If he does this there will be no excise tax for 2017 or for 2016 if he removes the excess Roth contribution for that year. Finally, his 5 year holding period for his Roth to be qualified cannot start with an excess contribution. That holding period starts with the first allowed Roth contribution.
Permalink Submitted by Douglas Bauerband on Tue, 2017-05-23 19:09
you he could remove all contributions since none of them were allowed. Can he just take the whole 50k out as a cash option and then he would not owe the excise tax?
Permalink Submitted by Alan - IRA critic on Tue, 2017-05-23 20:03
No, he would still owe the excise tax. If he withdraws the earnings in a non qualified distribution they will be taxed and subject to penalty if under 59.5. Perhaps he should do a small conversion just to start the 5 year clock since he apparently never made a legal regular contribution and may not be able to for some time. If he does a small conversion (perhaps 1000) then the 5 year clock will start running 1/1/2017 and eventually after 5 years and 59.5 all the earnings will be tax free.
Permalink Submitted by Douglas Bauerband on Tue, 2017-05-23 20:57
how can he do a conversion when no money was allowed to be invested in the Roth in the first place. He claimed a 100% exclusion of income and was never allowed to do a Roth IRA. The previous advisor never checked how he earned his income and started a Roth ira back in 2006. How can he keep any money in the Roth when he didn’t qualify for one?
Permalink Submitted by Alan - IRA critic on Tue, 2017-05-23 23:16
Because once he owed the excise tax, that allowed the earnings to remain in the Roth. As for the conversion, no earned income is needed to convert, but he must have an account to convert FROM, usually a traditional IRA or pre tax employer plan for which he is eligible to take a distribution.