New Client–Fixing old advisor mess up
New client came on board. He had a Roth IRA some old buddy of his set up. He made 2020, 2021, 2022 contributions directly to Roth. He makes over $250k and is a single filer. I was going to withdraw everything as an excess and then do his 2021 and 2022 as a back door contribution. Is there a better way? Should I recharacterize (since they were direct contributions, not conversions) and then convert the recharacterized? How would that work for 8606 etc?
Permalink Submitted by Alan - IRA critic on Tue, 2022-02-15 17:11
The 2021 and 2022 excess amounts can still be returned with allocated earnings to avoid the excise tax for those contributions. But it’s too late for the 2020 contribution, therefore a 5329 must be filed for the 2020 excess to pay the 6% excise tax. A 2021 5329 as well since the 2020 excess was still in the Roth at the end of 2021.
If client’s earnings on the 2021 contribution are high enough, client could opt to pay the 6% excise tax for 2021 as well as 2020, as that might be less than paying the tax and penalty on removal of the earnings. If so, the amount of the 2021 excess AND the 2020 excess should be distributed (no earnings calculation) by the end of 2022.
Am also assuming that client took NO distributions starting in 2020 that would have already been applies against the excess amount.
If the 2021 excess was not removed with earnings and each contribution was 6000, the excise tax on the 2020 5329 would be based on 6000, and on 12,000 on the 2021 5329.
Yet another option is to recharacterize the 2021 and 2022 contributions as non deductible TIRA contributions. If client has NO pre tax IRA balance, client could do a back door Roth conversion on these recharacterized contributions, and only pay tax on the gains on these contributions.
So there is a variety of mix and match options to address this situation. The first step would be to try to determine the amount of gain generated on the 2021 contribution to date. No reason to do that with the 2022 contribution since the market has been down since 2022 started.