Roth IRA – Removal of Excess
Hi,
Due to AGI limits, I’ve had to remove excess contributions from my Roth IRA that were made in 2010. The removal of excess also included removal of the earnings for those funds. I understand that the excess will be treated as if it was never contributed, but that I’ll have to pay an early withdrawal penalty and income tax on the earnings portion.
My question is: When is that earnings income reported? Even though related to 2010 contributions, the funds were removed in Feb 2011. So, shouldn’t it be reported in the TY2011 and not the current TY2010? Also, my Roth IRA provider says they will only report the removal of earnings as a 1099R in 2011.
So in summary:
2010 contributions made to a Roth IRA
Excess contributions and earnings removed in 2011
Excess contributions are ignored, earnings are subject to taxes
Do I report the earnings in TY2010 or TY2011?
Thanks in advance for the help!
Permalink Submitted by Alan Spross on Mon, 2011-02-28 19:34
2010.
You indicated that the contributions were made IN 2010. Therefore, the earnings that were removed will be taxable on your 2010 return and subject to 10% penalty unless you are 59.5. You will have to check the statements issued by the custodian in order to know how much earnings were generated since the 1099R will not be issued until next January.
That 1099R will be coded “P” on the 2011 1099R, with the P meaning it applies to the year prior to the current reporting tax year. That would be 2010 for a 2011 1099R. You can then ignore that 1099R with respect to your 2011 return because you will already have reported the corrective distribution on your 2010 return.
Permalink Submitted by Manoj Doolabh on Mon, 2011-02-28 19:51
Thank you for the quick response.
I am not 59.5, will need to pay the 10%, and do know the amount of the earnings.
Two followup questions please:
1. I am in the phase out range where I can still contribute some to my Roth IRA, but not the full amount. The calculation of how much excess to remove was a function of my income (AGI). Now that I have to report the earnings from the excess removed, does this not impact the total income? Or is the earnings from removal of excess not treated as income? It seems that, if I remove excess based on my income level and then report the earnings as income in 2010, that this act then impacts the excess amount calculation (in a perpetual cycle) since it changes my income calculation by adding the earnings to it.
2. Could i report it in 2011 using the 1099R as it will have the “P” designation?
Permalink Submitted by Alan Spross on Mon, 2011-02-28 20:45
1.) You are exactly right about this “chicken vrs egg” feature when you are in the phaseout range with an excess contribution. You could have avoided this cycle by recharacterizing the excess amount as a non deductible TIRA contribution and filing an 8606. Of course, if this would likely be your only TIRA basis, you would be stuck with an 8606 as long as you have any TIRA balance whatsoever, and that hassle may not be worth avoiding the phase out headaches.
1a) Another option that may be considered, especially if you have good earnings for the Roth contribution, is to leave the excess in the Roth, pay the 6% excise tax on the excess amount, and then contribute less this year so that the excess can be applied to 2011. In that case, your earnings stay in the Roth and will eventually be tax free. You avoid the tax and penalty on the earnings. You will need a 5329 to report the penalty for 2010 and another 5329 for 2011 to show the application of the 2010 excess to 2011. No penalty for 2011. Check out the 6% tax on the excess contribution vrs income tax on the earnings at you marginal rate plus 10%.
2) If you pull the earnings you cannot report them in 2011. The P coding makes reporting the earnings in 2010 mandatory.
3) To get out in front of the phase out cycle, you could take the math challenge to calculate how much extra of your contribution needs to be returned in order to prevent the earnings from resulting in a further phase out amount. As you can see, the better your earnings, but more viable paying the 6% excise tax becomes. At around 20% gains, the excise tax probably swings to advantage.
Permalink Submitted by Manoj Doolabh on Mon, 2011-02-28 21:22
This is an amazing forum with amazing results. Thanks very much for the informative and knowledgeable responses!
Unfortunately in my situation, the earnings from the excess contribution were enough to completely phase me out of Roth IRA contribution eligibility. As I wasn’t aware of this “chicken vs. egg” scenario, I only removed the excess calculated at the time not accounting for the extra income calculation from the excess’ earnings. Had I known, I would have had to remove 100% anyway as I now need to do.
I did consider recharacterization prior to removal, but decided against it simply because I did not want to deal with the hassle of mainting a non deductible TIRA.
As I’ve already removed the majority of excess, the return on my earnings was 8.8%, and I only have a slight amount left in excess, I think I’ll remove the full remainder and pay the taxes on earnings to keep it clean. I don’t anticipate being able to contribute any to the Roth in 2011 either due to the phase out again, so applying the excess to 2011 is not an option right now.
Thanks again for helping me make sense of this. Seems like a simple fix would be to exempt as income those earnings from removal of excess due to being in the phase out range. My 2 cents at least…