Removing 2013 Roth Contributions and Penalties

Submitted by Todd Martin on Wed, 2014-02-12 01:31

New clients made Roth IRA contributions in March of 2013 for the 2013 tax year. In April 2013, they completed and filed their taxes and made over the income limits to contribute to Roth IRAs at all. During an introductory meeting in January 2014, it was discovered they were over the income limits and should not have made those contributions to their Roth IRA. At this point, is it too late to do a return of excess or recharacterization to a traditional IRA? What is the tax penalty to them if the IRS catches this mistake? Thank you in advance for you help.



Submitted by Alan - IRA critic on Wed, 2014-02-12 16:21

  • The penalty is 6% of the excess contributions for 2013 and for each year the excess is not corrected. If the gains on the contributions are high enough, to preserve the gains in the Roth, it may be worthwhile to pay the 6%, and then either apply the excess to their 2014 Roth contribution (if eligible) or just withdraw the excess without earnings after 10/15 and before 12/31/2014. For this, they would need a 1040X to file Form 5329 and pay the 6% tax for 2013.
  • Or client can still withdraw the excess with earnings up to 10/15/2014, file an amended return to report the earnings and pay 10% tax on the earnings. This avoids the 6% penalty.
  • Or client can recharacterize the Roth contribution as non deductible TIRA contributions by 10/15. An 8606 could then be forwarded by itself to report the non deductible 2013 contribution. Of course, this would transfer the earnings back to the TIRA as well.
  • Note that there is no statute of limitations for excess contributions, so client should take one of the above actions.

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