I am “early retired” for 2020, and will be making a very large Roth contribution (evidently, there is no limit to how much can be contributed, only that it be documented as an excess contribution) to take advantage of extraordinarily low valuations in Emerging Markets due to COVID.

AIUI, I can apply unused ability to contribute to an IRA in subsequent years to knock this excess contribution (which continues indefinitely) down. But it seems that I can also knock it down by simply taking a Roth distribution (which is painless since I have the Roth contribution basis from the excess contribution itself). Now, if I wanted to have this excess contribution “consumed” in the same year of the excess contribution, I would need to take a distribution of both the contribution and any earnings (such as what would be done in a recharacterization of a Roth conversion, back when that was available). But it seems that this rule does not apply when “consuming” the excess contribution in a subsequent year, in that the nominal amount of the distribution – and not simply the contribution portion of a distribution – is used to knock down the excess contribution.

The accounting for the excess contribution is done in Form 5329 Part IV. Line (18) is the excess contribution for the year before (i.e., line (18)). Line (19) is the amount of unused contributability for the year (e.g., if the individual could have made a contribution of $7K but only contributed $2K, the unused contributability would be $5:). Line (20) is the amount of Roth distribution; the directions says, “Generally, enter the amount from Form 8606, line 19, plus any qualified distributions”, and it says nothing about this amount being only the portion of the distribution that applies to the contribution and not earnings. Line (21) is the sum of lines (19) & (20). Line (22) is the subtraction of line (21) from line (18). Line (23) is the excess contribution for this year, and line (24) is the sum of lines (22) & (23). The accessed tax is based on the amount on line (24). Thus,

(24) = (22) + (23) = (18) – (21) + (23) = (18) – [ (19) + (20) ] + (23)

so if there is no excess contribution for this year (line (23)), and even if there is no unused contributability (line (19)), this simplifies to

(24) = (18) – (20)

and thus all that needs to be done is to take a distribution, and that complete amount would “consume” the excess contribution.

So if I do a $20K Roth contribution in 2020 (presume no contributability), and that grows into $160K – yes, I’m being very optimisitic 🙂 – all I would need to do is wait until 2021 and take a distribution of $20K, and the total excess contribution penalty would be the 6% on the $20K for 2020, but nothing for it in 2021 and subsequent years.

Is this accurate? This seems to good to be true!