Over Funding of Roth IRA

Submitted by Mark Gilbert on Wed, 2020-04-29 19:49

I’m a relative novice with IRAs with the various rules. My question is that I’ve overfunded my Roth IRA for this year (2020). Since the market has been down due to the Coronavirus, I wanted to max out on my IRA now while prices are low and recently did max out out at $7k for the year (I’m 51 years old). I’ve had this IRA for several years now and some of my funds/stocks in this account did not reinvest dividends over the years.

My IRA account online shows cash available in the account. Of course, I don’t want to incur any taxes and/or penalties with a withdrawal. However, I’d rather have the money out of the account as I have places which pay more interest.

My question is, can I take out the cash balance out of a Roth IRA as a whole without taxes/penalties if dividend are mixed into cash amount shown? If not, how do I determine how much of the funds I can withdrawal without any taxes or penalties.

Please let me know your thoughts and thanks.



Submitted by Alan - IRA critic on Wed, 2020-04-29 20:47

  • It’s a real bad idea to take money out of a Roth IRA that you do not need, since Roth IRA earnings are tax free and there are no RMDs as long as you live. At the end of the day, what you keep after taxes is the key. If you close your Roth IRA, whatever interest you earn every year will be subject to taxes and tax reporting.
  • But to answer your question, in order to report a Roth distribution on Form 8606, you must determine what amount you have contributed over the years as regular contributions, conversion contributions, and the amount of any conversions done in the last 5 years. Regular contributions and conversions come out tax free, but taxable conversions done in the last 5 years will have a 10% penalty. Any balance in excess of your regular and conversion contributions are earnings, and the earnings will be subject to both tax and penalty.  On the other hand, once you reach 59.5, the entire Roth is tax free. Many people do not keep track of these figures and therefore are not able to correctly report a Roth distribution before 59.5. 
  • As for interest rates, they are going to be very low for many years now. Remember 2009-2016 coming out of the last recession.  The highest interest rates now are at the on line banks and you probably know who they are. These same banks also offer IRA accounts, and perhaps you could open a Roth IRA CD at one of these banks and have them transfer your current Roth balance into that Roth CD account. Then you will still have your Roth IRA, will earn more interest, and will not have to try to figure out how to report the distribution of your Roth IRA. 
  • If your Roth IRA is with the 3 major custodians, they offer brokered CDs that are FDIC insured, but right now the interest rates on these are considerably lower than the on line banks. That is not always the case, but it is right now. 

Submitted by David Mertz on Wed, 2020-04-29 21:14

  • It isn’t clear what you mean by “overfunding.”  Your $7,000 contribution for 2020 would only be an excess contribution that would have to be removed if you’ll have insufficient compensation in 2020 to support the contribution or your modified AGI for the purpose will exceed an amount determined by your filing status.
  • If it’s not an excess contribution, you can trustee-to-trustee transfer some or all of the account to another Roth IRA that has investment choices that meet your needs, so I don’t understand why you would want to take the money out if your intent is to keep it invested rather than having a need to spend it.   As Alan said, if you do not intend to spend the earnings before age 59½, it’s far better to have it grow in the Roth IRA with the growth being tax free once you reach age 59½ than have it grow in a taxable account where the growth will be taxable.

Submitted by Mark Gilbert on Thu, 2020-04-30 11:30

In order to purchase investments within my Roth IRA, I have to transfer funds to my online IRA account from my bank.  It appears I accidentally add funds greater than the maximum I can contribute for this year (2020)…was more than the $7k max given that I’m over 50 years old.  I’ve purchased some stock and funds this year in the amount of $7k and now have some residual, unused funds (cash) in the account.Thank you both for being patient and helping me understand the best course of action.

Submitted by Mark Gilbert on Thu, 2020-04-30 11:22

Very good point about the taxes incurred on the interest which could offset gains from other types of accounts outside the IRA.  My father turned me on to a Capital One 360 savings account which has much better returns than many other programs out there.

Submitted by David Mertz on Thu, 2020-04-30 12:21

  • A return of contribution before the due date of your tax return requires that any gains attributable to the amount being returned also be distributed.  The excess doesn’t apply to any particular investment in within the IRA, so those gains are calculated taking into account the performance across all of the investments in the IRA.  Those gains will be subject to income tax and early-distribution penalty.
  • If these gains are substantial, rather than pay income tax and 10% early-distribution penalty on the gains portion of a return of contribution, say 30% or more, you might consider leaving the excess in the account and paying the excess-contribution penalty, then correcting the excess after the due date of your tax return (including extensions).  Correcting after the dues date of your tax return would be done by either by applying the excess as part of the following year’s contribution or making a regular distribution of only the amount of the excess, which would be nontaxable.  Either would allow the earnings to remain in the account.

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