Roth IRA Overcontribution

Client made a $7000 Roth IRA contribution in April 2020. After 2020 taxes were done, income was higher than expected, so the max contribution was $3600. What does the client need to do before the tax filing deadline?



There are several options to handle this given that the contribution was made near the 2020 market bottom for stocks, and if the Roth has large gains in the past year, client may be better off paying the 6% excise tax on the excess 3400 to save the Roth gains. In other words, $204 might be lower than the tax and penalty on the gains if the excess were withdrawn in the usual manner.
Another option other than simply removing the 3400 with gains is to recharacterize the excess as a non deductible TIRA contribution. If client has no other non Roth IRAs, they could then convert the recharacterized portion back to Roth tax free except for the gains. If client does have other non Roth IRAs such as a rollover IRA, the conversion would be mostly taxable unless the client could roll the pre tax non Roth IRA amount including the recharacterized gains into their current employer plan, should it accept IRA rollovers. Then client could still convert the 3400 to a Roth IRA tax free.
The amount of work including transaction requests and tax reporting differs between these methods, but they all present roughly the same amount of work. If client has already filed the 2020 return, client may not want to remove the excess with gains since that would require an amended 2020 return.
To be clear, any return of excess or recharacteriztion would only apply to the excess. The 3600 allowed Roth contribution would be left as is.
First thing client should do is determine the % gain from the contribution date to the present. Month end Roth statements might be the best client can do unless the custodian will use their software to give him a net earnings quote. 

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