Roth IRA Excess for 2023
Client made Roth contribution in 2023 for full amount $6,500. His MAGI will only allow approx $3,000 to stay in Roth as a 2023 contribution. he has already made his 2024 Roth IRA contribution and very confident 2024 MAGI will allow full contribution for 2024.
His options are to remove excess ($3,500 plus earnings on this amount which is approx $1,000) or recharacterize the Roth excess portion to a Trad IRA and immediate convert to Roth which is plan.
My question pertains to the earnings on the excess of $1,000. I assume client has to claim earnings on 2023 return either way or does a recharacterization from Roth to Trad allow earnings to stay then pay tax on conversion (ie:$1,000) to avoid the 10% penalty on earnings or am I missing something? Trying to avoid claiming earnings and/or paying a 10% penalty on earnings if recharacterization prevents this.
Permalink Submitted by William Tuttle on Tue, 2024-02-06 20:48
Permalink Submitted by MIKE KRUCHTEN on Tue, 2024-02-06 21:53
I’m confused even more….The 10% tax I spoke to was in regards to the earnings which are indeed $1,000 on the $3,500 needing to be removed. There shouldnt be an excise tax since we will be removing the excess before he files 2023 taxes??Question still pertains to the $1,000 earnings. These are taxed at ordinary rates and excessed 10% penalty?
Permalink Submitted by Alan - IRA critic on Tue, 2024-02-06 22:07
If the contribution is removed (not what spiritrider recommended), the 1000 in earnings will be taxable, but there is no longer a 10% penalty on the earnings per a change in Secure Act 2.0. However, if the excess is not removed with earnings, the earnings can stay in the Roth and avoid taxes. The income tax on 1000 of gain is 250 assuming a combined state and federal marginal rate of 25%, while the excise tax is 210, which is lower. In addition, 1000 of gains would remain in the Roth IRA to eventually be tax free. Note that to prevent a second excise tax for 2024, the 3500 (no gains) needs to be distributed as a normal early distribution before year end. As such taxpayer has a choice to consider, generated by the 28% gain on the excess portion of the contribution, which is rare. With a more normal gain, taxpayer would just remove the excess with the gain.
Permalink Submitted by MIKE KRUCHTEN on Wed, 2024-02-07 13:11
If we recharacterize the excess(3,500) to a Trad IRA then immediately convert which is the likely plan what occurs with the earnings? Seems they are paid back to client then claimed as Ordinary income taxes in 2023 thou no formal tax document is created for the earnings or do earning get taxed in 2024 and can’t stay in IRA when a recharacterization is processed versus a removal of excess and earnings can stay in!!
Permalink Submitted by Alan - IRA critic on Wed, 2024-02-07 15:46
If the excess is recharacterized as a TIRA contribution, the earnings are also transferred to the TIRA, but since there is no distribution, no taxes are due. The TIRA contribution will probably be non deductible and would be shown as a 3500 ND contribution on Form 8606 for 2023. If there is no other IRA balance, the 4500 now in the TIRA can be converted to Roth with 1000 (the earnings) taxable. The conversion and conversion taxes on the 1000 will be taxable in the conversion year (2024). This is the so called back door Roth strategy which allows the 3500 to end up in the Roth by conversion rather than by a regular Roth contribution. It gets around the income limits. However, if there is any other TIRA,SEP or SIMPLE IRA balance then the conversion will be mostly taxable as calculated on Form 8606, on which the conversion is reported.
Permalink Submitted by William Tuttle on Wed, 2024-02-07 18:09