Excess Roth IRA contributions
We have a client who decided to do back-door Roth’s on their own. The problem is they funded the Roth’s directly, and now they have to remove them. Unfortunately, they funded Roth’s weekly from payroll deduction.
- Do they have to send the contributions back to their payroll or can they distribute the contributions to their checking account? I am hoping they can send them to their checking since the contributions were made with after-tax dollars.
- For TY 2022 they funded the Roth’s from their checking account. Do they need to send the excess to their checking account or can they send the excess contributions to their TIRA and then back? I think it’s cleaner to remove the contributions back to where they started.
Permalink Submitted by Alan - IRA critic on Tue, 2024-04-02 17:09
Excess regular Roth contributions for 2022 will have incurred the 6% excise tax for both 2022 and 2023. This must be reported on a Form 5329 with 1040X for 2022. If the 2023 return hasn’t been filed yet, the 2023 5329 can be added to that return.
The 2023 excess contributions can be recharacterized as TIRA contributions and then converted to a Roth IRA. The TIRA contribution should be reported as a non deductible contribution on Form 8606. However, if client has a pre tax IRA balance that would make the conversion mostly taxable, client should instead request a return of the 2023 contribution from the IRA custodian. The amount returned must be adjusted by the custodian for gain or loss. If there is a gain, it will be taxable on the 2023 return. The return should be made via a check to the client. Either of these processes will avoid an excise tax on the 2023 contribution.
Finally, the exact amount of the 2022 excess contribution should be distributed with no adjustment for gain or loss because the due date for 2022 contributions as passed and the excise tax will be due for both 2022 and 2023. There will be a 1099R issued next January, and this distribution must be reported on Form 8606, and should be non taxable.
Normally, a back door Roth is done by making a non deductible TIRA contribution and then converting it. Typically, there should be no other TIRA, SEP, or SIMPLE IRA pre tax balance that would cause the conversion to be taxable.
Permalink Submitted by Robert Roselli on Tue, 2024-04-02 17:24
Thanks for the detailed answer. I confirmed that the client doesn’t have a Traditional IRA set up. To confirm:
Even though the client funded their 2023 Roth contributions from their paychecks, they can set up a TIRA and have it recharacterized there and convert it back to their Roth?
For 2022, it sounds like it’s too late and all they can do is withdraw it. There is no option for a back door we’re passed the deadline.
Permalink Submitted by Alan - IRA critic on Wed, 2024-04-03 02:49
Yes, that is correct for both years.