2019 Roth IRA Excess Contribution

Submitted by MIKE KRUCHTEN on Tue, 2019-12-17 22:02

I posted a question last week regarding a 2018 Roth IRA excess contribution, it was answered very quickly and thoroughly so thank you..

The response has made me think about how to handle an excess 2019 Roth IRA contribution. I have a client who made a $7,000 2019 Roth IRA contribution which has grown to approx. $10,000. His MAGI will disallow a 2019 Roth IRA contribution. My understanding is by processing a excessive distribution he must take contribution($7,000) and all earnings ($3,000) the earnings will be taxed at client’s Ordinary Income bracket (32%) and 10% penalty on earnings. This totals a 42% tax rate on $3,000 creating a tax liability of $1,260!!! He may qualify next year to contribute to a Roth IRA but definitely will be in a slightly lower marginal tax bracket. Recharacterization not a good option since it wont be deductible and client already has a very large T IRA.

My questions are?

1) What is the harm of processing the excess Roth IRA distribution in March 2020 so earnings are taxed in 2020 versus 2019?

2) Leave 2019 Roth contribution in IRA, end of 2020 take the $7,000 out and pay 6% excise tax ($420) and allow current and future earning to stay in? Really don’t see benefit of processing a excessive 2019 Roth IRA distribution and forcing contribution and all earnings out!!! Opportunity cost on earnings then lost if removed?

What am I missing???



Submitted by Alan - IRA critic on Tue, 2019-12-17 23:58

  • You are correct. Large gains of 40% make it much more beneficial to simply pay the excise tax of 6% and keep those gains in the Roth. The 7,000 needs to be withdrawn by 12/31/2020 in order to avoid a second year of excise taxes unless it is clear that the 7000 can be applied as a 2020 contribution. If there is any doubt about the 2020 income being low enough to apply the 2019 excess to 2020, the 7000 distribution should be taken by the end of 2020. If it turns out that a 2020 Roth contribution can be made, it can still be done up to 4/15/2021.
  • Re Q 1 – with large gains, the income tax and penalty should be avoided and the gains kept in the Roth. Of course, if those gains evaporate and are lost by Sept, 2020, then the removal of the excess by 10/15/2020 makes more sense because the excise tax is then larger than the income tax and penalty, therefore avoiding the excise tax would save more.  Of course, in some situations there may be little difference either way but the two figures should be compared to see which tax is less. Either way, one year’s contribution is lost to the Roth IRA, but the earnings will not be if the excise tax is paid for 1 year. 
  • The excise tax for a year and the removal of an excess contribution with earnings are mutually exclusive, so once you incur the excise tax, the contribution for which the excise tax is paid should not be removed with earnings, but should be either removed or applied to the following year by the end of the second year to hold the excise tax to just one year.
  • If the excise tax is paid, but then the gains are lost and the contribution is removed with earnings instead, an amended return can be filed to get the excise tax refunded.

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