EXCESS ROTH CONTRIBUTIONS FOR YEARS

Submitted by Joseph Schwarz on Tue, 2025-01-07 16:24

I have new clients who have been contributing $50/mo to their Roth IRAs even though they haven’t been eligible for 10 years.
The custodian was able to handle 2024 and 2023 contributions through an excess removal form. They rejected forms for the other years.

How do we rectify this situation?

Thanks
Joe

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Permalink Submitted by Alan - IRA critic on Tue, 2025-01-07 16:50

The amounts of excess contributions for years prior to 2023 should be added up and a single distribution made. The earnings are disregarded and can remain in the Roth. The distribution should be non taxable since it comes from the balance of regular Roth IRA contributions. No reason to even tell the custodian that the distribution is for excess amounts because it is after the due dates for those years, and the distribution will be reported like any normal distribution. That is why the custodian did not accept excess removal forms for prior years.

Now the hard part. For each year starting with the oldest year, a Form 5329 for that year needs to be completed, and an excise tax will be due of 6% of the cumulative amount of excess contributions. Therefore, the first year excise tax will be based on that year’s contribution only, the next year for two years of contributions, etc. Form 5329, if completed correctly, will apply any regular distributions in these years to the existing excess amounts, but most taxpayers have not taken any such distributions.

The 2023 and 2024 5329 forms will not add another year to the total because those two years were corrected by the due dates, but there will still be an excise tax due on the total excess contributions as of the end of 2022. The 2024 form can be filed with the 2024 return, but the prior year 5329 forms should be filed with a 1040X for each year. There will also be a 2025 5329 due that would show that the excess amount has been eliminated by the 2025 distribution, and no excise tax will be due for 2025.

The IRS may or may charge late interest for the late payment of the total excise taxes.

It is unfortunate that the IRS did not flag any of these excess contributions in the past, even though they have the data to identify them. Almost suggests that they would rather let these errors pile up and then collect 6% excise taxes for every year. There has also been no statute of limitations in the past unless the taxpayer filed a 5329, but taxpayers do not file a 5329 if they don’t know an excess contribution was made. In the future, the SOL will be based on the 1040 filed and will be good for 6 years.

Obviously, the taxpayer should be very sure they were not eligible for those years before they withdraw from the Roth.