Roth IRA Excess for 2023

Submitted by MIKE KRUCHTEN on Tue, 2024-02-06 20:35

Client made Roth contribution in 2023 for full amount $6,500. His MAGI will only allow approx $3,000 to stay in Roth as a 2023 contribution. he has already made his 2024 Roth IRA contribution and very confident 2024 MAGI will allow full contribution for 2024.

His options are to remove excess ($3,500 plus earnings on this amount which is approx $1,000) or recharacterize the Roth excess portion to a Trad IRA and immediate convert to Roth which is plan.

My question pertains to the earnings on the excess of $1,000. I assume client has to claim earnings on 2023 return either way or does a recharacterization from Roth to Trad allow earnings to stay then pay tax on conversion (ie:$1,000) to avoid the 10% penalty on earnings or am I missing something? Trying to avoid claiming earnings and/or paying a 10% penalty on earnings if recharacterization prevents this.



Submitted by William Tuttle on Tue, 2024-02-06 20:48

  • The IRA excess contribution excise tax is 6% and not 10%
  • Since the excise tax would be $~3500 * 6% = ~$210 and marginal ordinary income taxes on that amount are almost certainly greater than that.
  • The client would be far better off:
  • leaving the $3500 excess contribution in the Roth IRA
  • Filing a 2023 Form 5329 and paying the 6% excise tax
  • Removing ~$3500 of the 2024 Roth contribution and earnings (which should be minimal).
  • This would allow filing a 2024 Form 5329 reconciling the 2023  excess contribution to available 2024 contribution space. This would result in a $0 excess contribution balance and no further Form 5329 filing.


Submitted by MIKE KRUCHTEN on Tue, 2024-02-06 21:53

I’m confused even more….The 10% tax I spoke to was in regards to the earnings which are indeed $1,000 on the $3,500 needing to be removed. There shouldnt be an excise tax since we will be removing the excess before he files 2023 taxes??Question still pertains to the $1,000 earnings. These are taxed at ordinary rates and excessed 10% penalty?



Submitted by Alan - IRA critic on Tue, 2024-02-06 22:07

If the contribution is removed (not what spiritrider recommended), the 1000 in earnings will be taxable, but there is no longer a 10% penalty on the earnings per a change in Secure Act 2.0. However, if the excess is not removed with earnings, the earnings can stay in the Roth and avoid taxes. The income tax on 1000 of gain is 250 assuming a combined state and federal marginal rate of 25%, while the excise tax is 210, which is lower. In addition, 1000 of gains would remain in the Roth IRA to eventually be tax free. Note that to prevent a second excise tax for 2024, the 3500 (no gains) needs to be distributed as a normal early distribution before year end. As such taxpayer has a choice to consider, generated by the 28% gain on the excess portion of the contribution, which is rare. With a more normal gain, taxpayer would just remove the excess with the gain.



Submitted by MIKE KRUCHTEN on Wed, 2024-02-07 13:11

If we recharacterize the excess(3,500) to a Trad IRA then immediately convert which is the likely plan what occurs with the earnings? Seems they are paid back to client then claimed as Ordinary income taxes in 2023 thou no formal tax document is created for the earnings or do earning get taxed in 2024 and can’t stay in IRA when a recharacterization is processed versus a removal of excess and earnings can stay in!!



Submitted by Alan - IRA critic on Wed, 2024-02-07 15:46

If the excess is recharacterized as a TIRA contribution, the earnings are also transferred to the TIRA, but since there is no distribution, no taxes are due. The TIRA contribution will probably be non deductible and would be shown as a 3500 ND contribution on Form 8606 for 2023. If there is no other IRA balance, the 4500 now in the TIRA can be converted to Roth with 1000 (the earnings) taxable. The conversion and conversion taxes on the 1000 will be taxable in the conversion year (2024). This is the so called back door Roth strategy which allows the 3500 to end up in the Roth by conversion rather than by a regular Roth contribution. It gets around the income limits. However, if there is any other TIRA,SEP or SIMPLE IRA balance then the conversion will be mostly taxable as calculated on Form 8606, on which the conversion is reported.



Submitted by William Tuttle on Wed, 2024-02-07 18:09

  • When you leave the excess contributions in the account. Only the excess contribution is subject to the 6% excise tax. Yet the $1,000 in earnings remain.
  • The 6% excise tax is only applied by the federal government. So the 6% excise tax amount should be compared to the federal, state and local (the latter two if applicable) marginal tax rates and net taxation of the earnings.
  • Even if the excise tax is > the total tax cost on the earnings. Paying the excise taxes and leaving the excess contribution and earnings in the account. Gets you an extra $1,000 in effective contributions vs. removing the excess contribution and earnings.
  • Removing the amount of the 2023 excess contributions and earnings makes the amount available to reconcile in a 2024 Form 5329.
  • Since it is early in the year any earnings on the amount removed should be minimal.
  • A traditional IRA recharacteriztion followed by a Roth conversion may be a better option. However as pointed out by Alan, any pre-tax balances in all traditional, SEP and SIMPLE IRA accounts by 12/31 any year Roth conversions are done.


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