Excess Roth Contribution
New client contributed to Roth IRA in May 2007. He then sold a rental and did some other things that made his MAGI exceed $200,000.
I understand he can withdraw the contribution and earnings before April 15, 2008 and pay taxes and a 10% penalty (under 59-1/2) on the earnings.
Two questions:
1 – how are the earnings calculated (I assume they are just proportionate gains in the IRA from the time of contribution to the time of withdrawal?)
2 – what if the Roth lost money between the time he deposited and the time he withdrew?
A – Does he withdraw the entire contribution or does he take a “proportionate loss”
B – How does he treat this on taxes?
Thanks in advance.
Permalink Submitted by Alan Spross on Thu, 2008-01-31 05:53
1) That’s right. The IRA custodian should be able to figure the earnings allocation. It is based on the investment experience of all investments within the particular IRA account during the time the excess contribution is there.
2) Then the earnings are negative, and the remaining net amount is what is withdrawn. There would then be no earnings to tax and no penalty. The IRS suggests the taxpayer attach a narrative statement explaining the correction of the excess contribution whether the earnings are positive or negative.
Client also has the choice of recharacterizing the contribution to a TIRA contribution and the same earnings calculation would be done to determine how much would move to the TIRA. However, due to his MAGI he will not be able to deduct it if he is covered by a retirement plan at work or if spouse is covered. He would then file an 8606 to report a non deductible contribution to the TIRA. With negative earnings it may be better to just ask the IRA custodian to return the excess contribution.
He actually has until the extended due date to do this, but should do it now if he wants to finalize his 2007 return.
Permalink Submitted by Denise Appleby on Thu, 2008-01-31 06:15
Some custodians will not do the calculation and have gone as far as to include a notification to that effect in their IRA agreement.
If they do not perform the calculation, the formula (provided by the IRS) in TD 9056 should be used to determine the attributable income ( earnings/loss). See http://www.retirementdictionary.com/nia.htm