Handling Excess Contributions to Roth IRA and Filling out 5329 Forms

Submitted by Eric Tam on Sun, 2020-02-23 21:17

Both my wife and I made max contributions to our Roth IRA in 2018 and 2019 ($5,500 and $6,000 each, respectively), but did not make any changes when we found our max contribution limits for each year to be much lower. In 2018, our limit was $1,898, and in 2019 it was $6,554.

If I understand correctly, my plan is that I would contribute $1,898 and then carry over $3,602 for 2019. On the 2018 Form 5329, I would indicate on Lines 23 and 24 my excess contribution was $3,602 and pay taxes on that. Similarly, my wife would show an excess contribution of $5,500 on her 5329 form and pay taxes.

For 2019, I would contribute $3,602 towards the family limit of $6,554, leaving $2,952 for my wife to contribute. This would come from her 2018 excess contribution, leaving a total remaining excess contribution of $2,548. I intend to have our 2019 Roth IRA contributions (and gains) removed and receive a 1099-R. I believe I am in the clear for 2019 and do not have to fill out a 5329, correct? On my wife’s 2019 Form 5329, I would put $2,952 for Line 19 and $2,548 in lines 22 and 24 and pay tax on this value. I am expecting to put this excess towards a 2020 contribution to avoid paying any more tax on the original 2018 excess contribution.

Are the actions I plan to take correct in this scenario? Am I filling out the forms properly?

Thanks for any guidance and input you can provide.

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Permalink Submitted by Alan - IRA critic on Sun, 2020-02-23 22:15

When MAGI to too high for a full contribution, the allowed amount is the same for both spouses. There is no family limit. Where is the 6554 figure coming from, since you indicated that max contributions were made for your ages? 6554 is higher than the max contribution.
Once you know the above, it is correct that you could remove enough of your 2019 contribution to create room to apply the 2018 excess to 2019 on Form 5329. However, if you have good earnings gains on your 2019 contributions, the tax and penalty on the earnings might be more than simply paying the 6% excise tax for 2019 (as well as 2018) and just distributing the remaining excess amount as a normal distribution.
If MAGI phaseout is going to be an issue every year, and if neither of you has a TIRA balance, you should be doing a back door Roth every year to avoid income limits. Do you expect that your 2020 MAGI will again be an issue?
When in 2019 did you make those contributions and can you estimate what the % gain has been to date? The stock market is up 20% or more over the last year, but maybe you are not in stock investments.
So far, other than these two contributions, have there been any other transactions done or requested?

Permalink Submitted by Eric Tam on Mon, 2020-02-24 03:13

I should have been more specific in regards to how I calculated our Roth IRA contribution limit. In this case $6554 was our combined earned income for the 2019 year ($1,898 was our combined earned income for 2018). I am used to making max Roth IRA contribution limits when I used to work but I mistakenly believed money derived from capital gains was also treated as earned income. I had previously taken advantage of the backdoor Roth when it was available to me during my working days. The 2019 contributions were made early in 2019, but the % gain (including dividends) is right around 8%. We have not performed any additional transactions other than the contributions, we are not planning on taking any distributions for the foreseeable future.

Permalink Submitted by Alan - IRA critic on Mon, 2020-02-24 15:14

OK. Were you the higher earner in both years? Only the lower earning spouse can receive a spousal contribution and this can become an issue when determining the contribution for each including years in which a prior excess is assigned to a future year.

Permalink Submitted by Eric Tam on Mon, 2020-02-24 17:37

In 2018, it was my wife’s earned income of $1,898. In 2019, $3,555 was my wife’s earned income, and the remaining $2,999 was my earned income. Was I mistaken in believing that I could split the earned income allocation however I saw fit? The tax software I was using to start my return indicated I could adjust the allocation between my spouse and I (and thus adjust each of our IRA contribution limit). If that’s not true, then will my math be that the I use these earned income values for each of us as our IRA contribution limits for the given year? In other words, only my wife can contribute $1,898 for 2018, contribute $3,555 for 2019 and carry over the remainder to 2020 (and pay additional excise tax), while I only contribute $2,999 for 2019? Should withdrawing my original contribution (and gains) be a consideration? I’m younger than 59, would the additional 10% tax be on just the earnings, or also on the original contribution amount of $5,500? I can do the math as long as I understand how everything is taxed.

Permalink Submitted by Alan - IRA critic on Mon, 2020-02-24 23:19

Well, I knew if I did this long enough, this fact pattern would emerge sooner or later. It’s quite complex. While you are the only spouse that can receive a spousal contribution for both year, and that is what you are planning, there is another deal breaker. You must both file a 2018 5329 to pay the 6% excise tax, and on those forms each spouse has to show their own excess contribution. The excess amount on line 24 of this form carries over to the 2019 5329, and then the allowed 2019 contribution must be enough to absorb this excess if the excise tax is to be confined to 2018 only.
Sec 219(c)(1) (Spousal Contributions) states that the max amount the spousal recipient (you) can receive in this case is the total earned income of both spouses LESS the contribution contributed by the higher earner (her). Since she can no longer remove her contribution with earnings and she contributed the max, it means that you cannot receive a spousal contribution for 2018 since her contribution is now locked in. While you could have received the full contribution if contributions were just being made now, or if she removed her contribution by 10/15/2019, that did not happen. 2019 contributions will be more flexible.
Therefore, her 2018 5329 will report an excess amount of 5500-1898=3602 *6% = 216. 3602 carries forward to her 2019 5329 line 18. For her 2019 5329, she has no contribution space because you are using it all (6554) as a spousal contribution. Therefore, she needs to take a regular distribution of 3602 in addition to requesting her entire 6000 2019 contribution returned. Check math – 11,500 original contributions less 3602 returned as flat distribution plus 6000 returned with earnings = 1898 net contribution.
Your 5329 for 2018 will report an excess amount of 5500 * 6% – 330. 5500 carries forward to your 2019 5329 line 18. You need 5500 of 2019 contribution space to absorb the 5500, so you need to remove 4946 of your 2019 contribution with earnings. That leaves you with 6000-4946 (removed with earnings) or a 2019 contribution of 1054 plus 5500 = 6554. The total earnings for both of you has been applied to your 2019 contribution as a spousal contribution. Check total math – you contributed 11500 and removed 4946 for a total of 6554 net contribution for the 2 years.
Net math check total original contributions made 23000. Reduced by returned contributions of 9,602 (her) and 4,946 (you) = 14,548. Net contributed is 8452, your total earned income for both years.
Check this over. You will probably have some questions. 2018 is locked in and determines how much of an excess each spouse carries into 2019. However, 2019 is still flexible when applying spousal contributions, but my impression is that you wanted your Roth contributions to be more than hers.

Permalink Submitted by Eric Tam on Tue, 2020-02-25 02:43

Thanks for all the helpful information and guidance thus far. If my wife does take the $3,602 distribution, is it subject to 10% penalty, or is it exempt because it was an after-tax contribution to a Roth? Would this $3,602 then be reported on Line 20 on the 2019 5329 form and taxed at 6%? The investments chosen in both of our contributions were similar so there is no preference, I just happened to reference my account to work from as a starting point. Does that make things easier for calculation purposes?

Permalink Submitted by Alan - IRA critic on Tue, 2020-02-25 03:43

Her distribution of 3602 must be taken before year end. It comes from her balance of regular Roth contributions and therefore will not be taxable or subject to penalty. However, it will have to be reported on Form 8606 for 2020. For excise tax purposes you are correct – line 20 of Form 2019 5329 will still have an excess of 3602 and generate a 6% excise tax. Removal of that amount in 2020 will reduce the excess to 0 for 2020 and no excise tax, but a 2020 5329 needs to be filed to show that line 24 is 0.
I did not actually fill out a 5329, so it would be advisable to pencil out 2018-2020 5329 forms for each of you to make sure these numbers actually work. I could easily have made an error somewhere.
Whenever spousal contributions and earned income below the limits are both involved, the solution is going to be very tricky. What would have made this much simpler in your case would be to eliminate the spousal contributions and have each spouse just contribute up to their own earned income for each year. The spousal contributions did not increase the total contributions allowed due to the low combined earned income, so they are of no value here. Doing it that way, she would have made 5,453 in contributions and you would have made 2,999, the same total as under the the prior scenario, but more would be in her Roth and less in yours. Of course, the removal amounts of the 2019 contributions would change and also the regular distribution of the remaining excess. Total income tax and excise taxes would be the same.
Note that removal of the 2019 contributions with earnings should be done soon if you want to avoid an extension, because any earnings will be taxable on your 2019 return, and subject to penalty.
Just be sure the numbers check out on the 5329 forms, maybe do a rough draft before ordering the contributions returned. You can also file the 2018 5329 forms stand alone anytime since those excise taxes are fixed. Then bring the remaining excess forward to the 2019 5329 forms. The IRS may or may not choose to charge late interest on the late payment of the 2018 excise taxes.

Permalink Submitted by David Mertz on Tue, 2020-02-25 14:05

I question whether or not it is even permissible to allocate any of W’s $3,555 of 2019 compensation to H, given that W has excess contributions from 2018 of more than $3,555. The instructions for line 19 of Form 5329 seem to imply that all of W’s $3,555 of compensation must be included on W’s line 19, leaving W with $47 of excess carrying into 2020. That would result in only H’s $2,999 of 2019 compensation appearing on H’s line 19 and $2,501 of excess carrying into 2020. (For what it’s worth, the tax-return software that I use treats any other allocation as erroneous.)
Also, it appears that H was under age 50 in 2019, so even if some of W’s 2019 compensation is permitted to be allocated to H, no more than $6,000 of combined compensation could be allocated to H for 2019.

Permalink Submitted by Eric Tam on Tue, 2020-02-25 14:05

It does sound easier for 2019 if I just allocate our contribution based on each of our earned income. I had just gotten used to filling my IRA first and then doing my wife’s IRA afterwards when we could each contribute to the max limit. Regarding the portion of the 2018 over contribution that can’t be put towards the 2019, is it also correct that I could choose to carry it over and apply to our 2020 IRA contribution? That would mean one more year of paying the 6% excise tax next year before I finally zero out that 2018 contribution. It also appears to only make sense to leave it in there if I believe the investment will grow more than 6% this year to make up for the tax penalty, but that’s a totally different discussion for another day!

Permalink Submitted by David Mertz on Tue, 2020-02-25 14:14

I think tammerman77 and I posted nearly simultaneously. Yes, whatever excess remains for each of you after applying the permissible amounts of excesses from 2018 as your respective 2019 contributions carries over to 2020. You can either obtain regular distributions of those amounts before the end of 2020 or you can apply them as part of your 2020 contributions. If near the end of 2020 there is any question as to whether or not the two of you will have sufficient compensation to be able to absorb all of the remaining excess, you’ll want to obtain the regular distributions of the excesses and then make new contributions for 2020 depending on your ultimate compensation.

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Handling Excess Contributions to Roth IRA and Filling out 5329 Forms

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