IRA contibution now partially non deductible due to MGI

Submitted by Todd Cour on Thu, 2017-04-06 22:49

I am looking for some clarity on the following situation:
$2400 went into an IRA through automatic monthly deposits. Spouse ends up being covered in a new employer plan for 2016 making it such that both spouses are now covered by employer plans. The income situation puts them in a partially, not fully deductible situation.
I am looking for clarity on the options.
1) Can you just pull simply pull out/distribute the non deductible portion if one would rather not track and report it with form 8606……in other words, not mess with tracking the ND portion of the contribution and take out what is already in the IRA but now appears non-deductible.
2) Rather than just distribute it out and then make a 2016 contribution to a new ROTH (income is fine to make the contribution)….would it be more simple to open the Roth and have the ND portion converted or re-characterized????? (need some clarity on process)
3) Any other thoughts are welcome.

Thank you for the assistance.



Submitted by Alan - IRA critic on Thu, 2017-04-06 23:21

  1. A return of only the non deductible portion can be requested, but if the contribution was made in 2016 the earnings returned could be enough to increase the non deductible portion since the earnings would be taxable for 2016.
  2. Especially if there are earnings, it might be better to have the non deductible portion recharacterized as a Roth contribution, since the modified AGI threshold for Roth contributions is considerably higher. This cannot be done by conversion, only recharacterization or by withdrawing the non deductible portion with earnings and then making a new Roth contribution with the ND portion by 4/18. Again, if there are earnings rather than losses on the ND portion, better to recharacterize than having earnings increase the ND portion.
  3. With a partial recharacterization, spouse would end up with a deductible contribution for the allowed amount and a regular Roth contribution for the remainder.

Submitted by Todd Cour on Fri, 2017-04-07 17:18

Alan….first of all, thankm you for the information.1) To find out the amount of return on the ND portion, would it simply be similar to the following example – if the ND portion represents 28% of the 2016 IRA conribution and the 2016 return was 10% for example, then 28% of the 10% could be allocated to the ND portion as the ND portion’s part of the return? What if the contribution was made throughout the year in pieces…….it gets infinintly more complex at that point…..is there a straight forward way to determine that is acceptable for the IRS? (the growth also may not be worth the trouble is possible)2) At this time there is NO Roth account opened. I am prepared to do that after gaining the clarity you are helping me with. If there is NO growth or so little that it is a headache, I am understanding that I can make a distribution of the ND portion and it becomes a 2016 deposit for the new Roth account…CORRECT? Secondly….if I can easily determine the growth, while I can just distribute the ND portion…..I can’t just distribute the growth?? Is that why you suggest re-characterization? 3) With re-characterization…I open the Roth (or in other cases use the existing), while all is completed at the custodian…….is there anything that must happen from a reporting standpoint with the IRS that the custodian doesn’t typically handle automatically?Thank you for your efforts in answering and clarifing the above!

Submitted by Alan - IRA critic on Fri, 2017-04-07 18:00

  1. The earnings on a contribution is determined by IRS formula explained here:  http://retirementdictionary.com/definitions/netincomeattributablenia  .  If you make monthly contributions the custodian would add them all up and consider that total as part of the adjusted opening balance. This is a compromise that prevents the custodian from having to do a separate calculation for each contribution date.
  2. If there is no earnings after the calculation used by the custodian, then yes you could request a return of the ND portion and would get back that amount. If there was a loss, you could get back less but there would be no earnings returned that would result in a further increase of the non deductible portion of the contribution. The distribution of the ND portion would not automatically become a Roth contribution, you would have to make a new contribution or you may be able to instruct the custodian to apply it as a new Roth contribution for which the deadline is only 10 days away. If you want to do a Roth contribution, I would open the Roth account and make the contribution now to be sure it is the right amount and then put the returned contribution in your checking account when you get it. Less chance for an error, particularly due to the fact that you are not going to get back the exact amount of the excess. It will be somewhat more or less, but your Roth contribution cannot be more than 5500 less the deductible TIRA contribution, ie 5500 total for both of them.
  3. Suggested recharacterization when there is growth because that transfers the gains to your Roth IRA as if the ND portion had originally been contributed to your Roth IRA. It also avoids distribution of growth that will be taxable and subject to penalty and because it is taxable it will increase your ND portion like a chicken and egg situation. The more growth there is the better recharacterization becomes. You could even do this with a small loss since you would not have to handle the money, but your Roth would open with less than your ND contribution due to the loss.
  4. Whatever you do, the custodian will report it on a 1099R. You become responsible for your tax return. For the tax year that is affected by the return or recharacterization, you must include an explanatory statement of what you did because the 1099R will not be issued till next January, even though tax year 2016 is the year affected.
  5. Example of recharacterizing the 2016 ND portion as a Roth contribution. 2016 return would include explanatory statement about the recharacterization. The return would show the IRA deduction for the deductible TIRA contribution, but the Roth contribution is not reported. There would be no 8606 reporting a ND contribution because that portion was turned into a Roth contribution. The 1099R would be coded to apply to 2016, so this would NOT affect your 2017 return.

Submitted by Todd Cour on Fri, 2017-04-07 18:58

Alan,Thank you…..great explaination and further clarification!

Submitted by Todd Cour on Mon, 2017-04-10 23:15

Alan,Just some clarification on #4. The custodian has been notified and they suggested I mark “excess contribution” and explain again in notes…which I have done. The partial distribution will be for the exact amount of the 2016 ND portion. The growth was negligible as the excess was a small amount so after discussing with the client, just the ND portion was authorized. Correct me if that seems wrong.On the eplanatory statement……since the client is filing with turbo tax, I assume there most likely is a note section of some sort…..we will check on this of course. The section for IRA contributions is filled in with the correct 2016 deductible amount and the Roth section has been completed with the correct 2016 Roth contribution amount which is the previous ND portion. My question on this point is to ask if simply stating the following would be sufficient:A $1460 distribution from XYZ traditional IRA account at XYZ custodian due to the fact the amount was non deductible for 2016 and therefore should have been a Roth contribution. The distribution was for the non-deductible portion only and the same amount has been now been conrtibuted for a 2016 Roth.  Is that OK? Can you suggest corrective language? Thank you.

Submitted by Alan - IRA critic on Tue, 2017-04-11 00:00

Even if there were NO earnings, the custodian must do the calculation and code the 1099R to show a return of the specific ND portion was done with allocated earnings. The 1099R coding will tell the IRS that the proper calculation was done, but there happened to be no gain or loss. Showing “excess contribution” on the request should produce the correct 1099R coding so you should be OK. Client’s explanatory statement should indicate “On (date) I received a return of $1460 of my traditional IRA contribution for 2016, which was worth $1460 at the time of distribution”. No need to mention the Roth re contribution.

Submitted by Todd Cour on Mon, 2017-04-10 23:19

Another client want $8k from his Roth account. He has verified that all $8k would come out of basis and he has had a Roth longer than 5 years of which his basis was a conversion so that has been verified to be aged older than 5 years. It would seem to me to be a clean distribution (I recommended against but his call). Do you agree assuming the above is correct?What kind of notification should be included in his tax return to ensure no penalty for being younger than 59 1/2….. if necessay?

Submitted by Alan - IRA critic on Tue, 2017-04-11 00:17

He can just report per the 1099R he will receive next January. Since he apparently has no basis from regular contributions in the Roth (just conversion basis), he will show the 8,000 on line 19, 21, and 23 of Form 8606. Enter his total conversions on line 24. If more than 8k line 25 will be 0. No need to for explanatory statement in this case.

Submitted by Todd Cour on Tue, 2017-04-11 16:59

thank you

Add new comment

Log in or register to post comments