Contributed to Traditional IRA thinking its a RothIRA

Submitted by John Benjy on Wed, 2014-10-22 22:23

Hi, I am 36 years old and am in the 28% tax bracket, wondering if any of you faced with this situation or know what should be done to resolve this to minimize the tax implications on an honest mistake. I thought I opened a Traditional IRA (say Account1) and a Roth IRA account (Account2), but the brokerage says I had opened two Traditional IRA accounts. I made two contributions in Account2, $4K in 2006 and $5K in 2009 and filed in my tax returns as Roth Contributions. I also had $5K contribution in 2009 in Account1. In 2014 I took out $19K from Account2 towards downpayment of home assuming there will be no tax implications as its a withdrawal of contributions ($9k) from Roth and qualified distribution of $10K towards downpayment of home. The value of the investments in Account2 is now worth $180K. Now as I discovered that the brokerage has been tracking Account2 as a traditional IRA, how should I go about correcting the issue.

Any pointers is greatly appreciated,

Thanks,



Submitted by Alan - IRA critic on Wed, 2014-10-22 23:02

  • While several of these years are now closed, the IRS has been accepting retroactive Form 8606 filings reporting non deductible TIRA contributions. Even if you had been able to deduct those contributions, those tax years are closed, so the non deductible contribution is your only option. You would file the appropriate year 8606 reporting non deductible contributions, but only the allowed amount for the year. You do not report regular Roth contributions on your return, and the 5498 issued for each contribution evidently indicated TIRA contributions, and that is how the IRS will view them. Irrespective of the type of IRA contribution, you made excess contributions in 2009. There is no statute of limitations for excess contributions, so you need to file a 5329 for 2009 and pay the 6% excise tax on the amount of the excess. You also need a 5329 for each year thereafter, unless you did not make a contribution in one of those years that you were eligible to make. If you have earned income you are always eligible to make a TIRA contribution, but you may not be able to deduct it. So if you qualify to apply your 2009 excess to 2010, you would only owe the 6% for 2009, but would file a 5329 for 2010 to show that your outstanding excess amount from 2009 was applied to 2010 and there would be no excise tax due for 2010. Even if you do not qualify for any of those years, your recent distribution would take care of the excess amount in 2014, but you would owe the 6% for each year through 2013. The 2014 distribution is obviously a TIRA distribution, not a Roth distribution, so would be taxable except to the extent of your non deductible contributions, which were 9,000. Since your total TIRA balance was something more than 180k, more than 95% of your 19k distribution would be taxable. Finally, if this qualified as a first home distribution, your penalty would be waived up to 10k.
  • If you think the brokerage is at fault, since so much time has passed, it is unlikely that if you proceed against the broker that you would win. They would just take the position that you should have checked your paperwork and your 5498 forms after making the contributions. This could have been corrected easily for several months after the contributions were made, and the length of time is what makes the process time consuming and costly.
  • I assume more than 60 days has passed since the 2014 distribution, so too late to roll it over unless the purchase fell through and then you have 120 days.
  • Please advise if you need to know the contribution limits for 2006 and 2009 and if you were over 50 in either year.

Submitted by John Benjy on Thu, 2014-10-23 00:41

Thank you very much for the detailed response. This was very helpful, cleared up a lot of things. Its been 50 days since taking out $9k contribution and 35 days since taking 10K distribution towards first home purchase. I will talk and plead with the brokerage to correct the status of the account as I was assured over the phone a couple of years back that it would be corrected and to not bother what it says on the account. If nothing else, I will pay the penalties and taxes and may be roll it to Roth over multiple years. Can I roll over 10K this year and spread the rest in the years when my income is low.

Submitted by Alan - IRA critic on Thu, 2014-10-23 03:05

  • That is seriously misleading if the brokerage told you to ignore what is on the account statement. I would plan to leave that broker in the dust when first convenient since they obviously cannot be trusted to give you straight information. You can convert up to 14k of your distribution to a Roth if you think it is beneficial to pay the taxes, or you could roll up to that amount back to the TIRA if you do not want to pay the taxes. Leave the 5k out because that is a withdrawal of your 2009 excess amount. Getting the 8606 forms filed to report the basis should be done before you report the conversion in order to correctly complete the 8606 for the conversion with the correct taxable amount.
  • Your only excess contribution was the 5k additional contribution for 2009.

Submitted by John Benjy on Sat, 2014-10-25 03:55

After multiple long conversations with the brokerage, it turns out that my account is a Traditional IRA and the contribution of 5K was for 2008 and so it was not an excess contribution. So wondering if I can put the money back into the same IRA using 60day rollover option so that I do not get penalized/taxed on the withdrawals. I withdrew 9K in early september and 10K in mid september. Wondering if it will be considered two rollovers if I try to deposit 9K on Monday and 10K on Tuesday next week using 60day rollover option (as I found that there is a limit of 1 rollover in 365day window). I had withdrawn 10K from my wife’s Roth IRA towards first home purchase downpayment and it was brought to my attention that we can only take 10K over all from all our IRAs combined towards first home and not 10K each.

Submitted by Alan - IRA critic on Sat, 2014-10-25 04:30

  • You can EACH take up to 10k lifetime to apply to the first home purchase exceptions. If the distribution is from a TIRA, the first home exception will waive the penalty on the taxable portion of the distribution. There is NO penalty on the non taxable portion if your 8606 forms are up to date indicating your basis from non deductible contributions. You are correct about rollovers. Up to the end of this year you are only allowed one rollover per IRA account, and you took two distributions. Therefore, only one of them can be rolled back or to another TIRA and the other must remain distributed and taxable. And all this assumes you did not roll over another distribution in the prior 12 months in which case you would not be able to roll over either of the two recent distributions.
  • Apparently, you do NOT have an excess contribution, so there is no need for a 5329 and you do not owe the excise tax. But you need to get those 8606 forms filed to reduce the taxes on your current distributions and future distributions or conversions.

 

Submitted by David Mertz on Sat, 2014-10-25 12:39

Since you can apply the first-home purchase exception to your $10 distribution, you may only want to roll over the $9K distribution.  However, if you want to return both of these distributions to retirment accounts, some or all of one of two distributions from your traditional IRA can be rolled back to the traditional IRA while the rest can converted to a Roth IRA; Roth conversions are disregarded with respect to the one-rollover-per-12-months rule.  Of course you’ll still owe ordinary income tax on the portion of the Roth conversion that is not attributable to basis in the traditional IRA.  (You indicated that your original intent was to have some of this money in a Roth IRA anyway.)

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