Roth IRA setup as a Traditional IRA by Fund Custodian
Hi folks, it took me a while to notice (almost 10 years to be exact), but I have noticed a huge mistake made by my IRA custodian for one of my IRA funds. The IRA was made in 2003 for the 2002 tax year, and I contributed the maximum allowed, $3,000. It was supposed to be established as a Roth IRA, but all this time it has been structured as a Traditional IRA. I have proof that it is their mistake because I have a copy of the contribution form marking it as a Roth, and when I called up the custodian, they acknowledged it was their mistake.
I first spoke with the custodian February 1st, and haven’t heard back from them since. I have called a few times, and they say they will contact me when they find a solution. Understandably, this appears to be a very difficult issue for them, but I’m a little concerned that I’m being ignored, as I only have about $5,000 in the fund. All my IRAs are Roths, spread out among several funds, and I very much prefer Roths so that I can withdraw the earnings tax free at retirement, or possibly withdraw from the principal without consequence if necessary, both of which I cannot do with the Traditional IRA. True, I could just leave it as is as a Traditional IRA, but I never took the necessary deduction in my 2003 tax return. Without the benefit of a deduction, I have no incentive to leave it as is as a traditional IRA!
Has anyone run into a similar situation? I feel foolish that I had not caught this mistake sooner, as it was basically staring me in the face on the fund’s website all this time, but I need to correct this soon. I am unemployed with no income at the moment, and imagine I will be for the near future, so the possibility of taking the missing tax deduction this year or next is not feasible. Is there any possibility I could file an amended 2002 tax year return to retroactively claim the missing deduction? And this is assuming the IRA stays traditional. If they were to correct this issue by converting it to a Roth, I would then be stuck paying taxes on the contribution amount, even though it was supposed to be setup as a Roth in the first place with my after tax dollars!?!?!?!? Since it’s the administrator’s mistake, shouldn’t they eat the loss and reimburse me if I have pay the taxes to the IRS to convert to a Roth, or if nothing can be done, they could reimburse me the opportunity costs of not taking the deduction in my 2002 tax return.
Anyways, this is a rather complex situation that I hope to resolve in a timely manner, and I look forward to your expert analysis!
Permalink Submitted by Jose Morales on Tue, 2013-03-19 16:11
First, did you file an 8606 with your 2002 tax forms to declare the non-deductible contribution? If not, that is a good place for you to start, since that was also your responsibility to take care of in 2003. Do you also happen to have the 2002 5498 that you received in May of 2003? Did it show a Traditional or Roth contribution? You say you have a deposit slip clearly marked to make a 2002 Roth contribution? Had you actually established a Roth account by completing the necessary Roth application and received the required Roth disclosures prior to making the contribution? This would be the first step necessary to make a Roth contribution if you hadn’t already done so in a pror year.If you have the Roth application and the deposit slip clearly marked requesting a Roth contribution then I don’t see why the custodian would refuse to make any necessary corrections, unless they want to take the stance that you share in the mistake by allowing the account to sit uncorrected for so long while receiving tax forms every year clearly showing the account as a Traditional IRA. They may be waiting to hear back from the IRS as to how they would prefer a correction be made for a mistake that dates all the way back to tax year 2002.A conversion should not be done to resolve this if you truly established a Roth, but if that were the method of correction that you agree to you would only be taxed on the earnings since the initial contribution, as you never took a deduction for the $3,000 contribution when it was made. I wouldn’t want to fix this problem by converting the account.
Permalink Submitted by aj domingo on Wed, 2013-03-20 00:37
I never filed a 8606, since I had no intention of making a non-deductible contribution, let alone a Traditional IRA contribution. I did receive a 2002 5498, and it lists the IRA as “contributory IRA”, clearly not a Roth IRA. So, that should have been the first sign to me that it was setup wrong, but alas, I didn’t catch it. And, the custodian knows this because the customer service person pointed it out to me on the phone the first time I called.At this point, I’m gathering some opinions from folks like yourself throughout the web to see what the best option is to respond to the custodian. If I don’t hear back from the custodian in the next 2 weeks, I intend to send a letter certified mail asking for a definitive response. Not to complicate matters, but I also just rolled over a pension balance from my old employer to this custodian to be specifically setup as a Traditional IRA, since I do not have the funds to pay the tax for a Roth conversion for this portion of funds. With that said, I am not entirely opposed to having a Traditional IRA, in fact, I heard some people “diversify” and have both Roths and Traditional IRAs, and if it turns out that leaving the original Roth IRA funds in the traditional account setup by mistake is the best option, so be it. I just want to get this squared away once and for all, and that means I should be reimbursed for a missing tax deduction if the account stays in the traditional account, or converting to a Roth, but with zero to little tax ramifcation for me since I have no income tax to speak of.
Permalink Submitted by Alan - IRA critic on Wed, 2013-03-20 03:27
I would give them some more time to research this, since there is no clear procedure for them to take to correct this, and they need some time to research this, probably with the IRS. It seems logical that the solution would be to transfer the funds to a Roth IRA (not a conversion) and correct the 5498 for the original contribution to that of a Roth. That would enable you to avoid tax on the gains. If they refuse, there is not enough value here to pursue any legal action beyond a bluff. If that also does not work, your next back solution is to file an 8606 for that year (download correct edition), as it is too late to deduct the contribution now since the tax year is closed. You probably would not want to convert the account because your pension rollover will make the 5,000 conversion mostly all taxable, but you could still convert some or all of your TIRA if an analysis indicated you could do so at a tax rate equal or lower than what you expect to pay in retirement.
Permalink Submitted by aj domingo on Wed, 2013-03-20 08:08
Thanks Alan, I appreciate the response. I am hoping that the fund administrator is conducting research with the IRS on the best way to resolve this issue. They pretty much have said as much the first and second time I spoke with them, so I’ll just try to take them at their word and let them do their work. I have no idea how these things work, but I would think their must be a procedure that allows them to work directly with the IRS to fix messes like this so that the client is not stuck paying penalties for their mistakes, regardless if said client should have noticed the mistake in a timely manner or not. Also, the custodian is one of the biggest mutual fund companies in the world, and I have been a loyal client for about 15 years or so, and that kind of gives me peace of mind that this will ultimately be resolved in a sensible fashion.
Permalink Submitted by Jose Morales on Wed, 2013-03-20 16:14
Just a clarification on the form 8606, you need to file that with your taxes any year in which you make any type of non-deductible contribution whether it is made to a Traditional IRA or it is a Roth IRA contribution. So regardless of how this all plays out you need to file an 8606 for tax year 2002. Because of the length of time since this occurred there is no clear cut method of correcting this. If it had occurred within the past 3 years it would be as simple some file maintenance to the account and correcting any of the tax forms that have been sent out. If the IRS suddenly received a corrected 5498 for tax year 2002 they will probably scratch their heads and not know what to do themselves.Taking a wild guess from my own instances of correcting IRA mistakes from accounts more than 5 years old with the guidance of the IRS, they will most likely reclassify the account as a Roth and submit corrected tax forms for the past 3 years only. I wrote a very detailed summary on company letterhead for the clients to keep for their records and in the event that they ever have issues with the IRS in the future as well.
Permalink Submitted by mk foss on Wed, 2013-03-20 17:19
No reporting is required for a Roth contribution. Form 8606 is required for a traditional IRA every year that you make a nondeductible contribution or take an IRA withdrawal. The Roth conversion of a nondeductible IRA is considered a withdrawal for this purpose.
Permalink Submitted by aj domingo on Mon, 2013-04-29 01:34
Hi folks, it took a while, but I was patient and waited to call the administrator last Wednesday to find out the current status of my issue. If I didn’t hear back from them this time, I was prepared to send a written notice via certified mail that I needed to have the issue resolved one way or the other in a timely manner, or I would move other Roth IRA funds I intended to transfer to them to another fund custodian. It turned out that I was able to talk to someone from customer service who was sympathetic to my issue, and when I explained that I was about to the reach the 3 month mark with no resolution or even some timely updates to me by phone, he made sure that I would get a substantive update the following day. And sure enough, a professional from the fund’s problem resolution department called me and gave me some good news: they are going to change the characterization of the IRA from traditional to Roth with no tax implications or paperwork headaches for me! As they originally acknowledged, they admitted they made the mistake of characterizing the original distribution as a Traditional IRA, so they apparently must have worked out some kind of deal with the IRS behind the scenes to fix it so that I was not on the hook for paying taxes on the conversion. To be precise, this was never supposed to be a Roth conversion, but not knowing how the fund administrator was going to treat my issue, I feared that I would be stuck paying the tax penalty.Anyhow, I wanted to thank you folks for your attention to my matter, and I others learn from my mistake. Always double check the correspondence from your financial institutions to make sure there are no errors and if you see something is amiss, bring it to their attention immediately. This is a world class financial company, and they make mistakes like the rest of us.
Permalink Submitted by Jose Morales on Mon, 2013-04-29 16:36
So glad to hear you finally had this resolved, even if it was a little slow in coming. On a side note, I do apologize for the incorrect information I gave regarding the 8606. Just a complete lapse in thought on my part.
Permalink Submitted by aj domingo on Tue, 2013-04-30 07:53
No apologies necessary, really. This is all complicated stuff, at least to me, and I appreciate the guidance of experts on this subject matter.One more note, now that the Roth classification has finally been set up, I intend to move over some Roth IRA’s I hold at some other financial institutions to this provider, which is the flagbearer for index funds in the world. I had been meaning to trim my actively managed fund holdings and switch those them to index funds, since for the most part, managed funds fail to outperform their benchmark and charge big fees for the priviledge!