Excess Roth contribution options
I asked a question last week and did some research. I have a client who makes too much money to contribute to a Roth. He already filed his 2020 taxes. He had to pay the 6% penalty. I know he can leave the excess contributions in there and keep paying the 6% excess tax, he can recharacterize them to his Traditional IRA and re-file.
Since he already paid the 6% excess, does he also have the option to recharacterize the contributions in 2021, so that he doesn’t need to re-file his taxes?
Permalink Submitted by Alan - IRA critic on Tue, 2021-03-09 15:37
The 2020 Roth excess could be recharacterized as a TIRA contribution (although likely not deductible). That would cure the excess and Form 5329 could be amended to request the return of the excise tax paid. Form 5329 is itself a return, so a 1040X should not be needed to amend the 5329. Another option is to request a return of the excess with earnings, and while the earnings would be taxable in 2020 if the excess contribution was made in 2020, this would also allow the excise tax to be refunded by filing an amended 5329.
That said, if client made the contribution in early 2020, there could be considerable gains that would be taxable upon return. In that case, the excise tax already paid could be less than what the tax and penalty would be if the contribution and earnings were returned.
If client wants to protect the earnings by sticking with the excise tax already paid, client could wait until late this year and simply reques a return of the amount of excess. That would produce a tax free distribution (return of Roth regular contribution), and would limit the excise tax to 2020. Earnings would be allowed to remain in the Roth.
Therefore, to select the best option, he needs to know what the earnings to date are on the 2020 excess contribution. Generally, 25% would be an inflection point, so the Roth would have to be invested in stocks to generate that much of a gain.