Roth IRA Over Contributions

Finding out you made too much money is often a pleasant surprise. Except when you now owe additional taxes and learn that you were not eligible to make the contributions you already made to your Roth IRA.

As a reminder the Roth IRA accepts after tax contributions which accumulate tax deferred. Distributions are received income tax free as long as the owner is over age 59 ½ and the account is at least five years old. The tax advantage is that income tax is never paid on any growth over the contributions.

Like most good tax deals, eligibility to contribute to Roth IRA's diminishes as income increases. In 2007, assuming a couple who are married and filing jointly, eligibility to contribute to a Roth IRA started to phase out at $156,000 and was eliminated once adjusted gross income passed $166,000. For 2008 the phase out range is $159,000 - $169,000.

Suppose you find yourself in the same position one of my clients did. Business at the end of 2007 was very good. His bank balances were high and he wanted to take advantage of the sharp market decline by buying low. In early February he made both a maximum 2007 and his 2008 contribution to a Roth IRA by purchasing a mutual fund.

In March he called me in a panic. "I just got back from my accountant's office" he explained. "My CPA told me I put too much money in my Roth. Apparently I can only contribute $X,000." He asked, "How do I fix it?"

"Relax", I told him. "It's not a big deal. All we need to do is remove the excess contribution and any associated earnings. It's fairly common and routine."

In his case we contacted the mutual fund company. Since he liked the investment and the purchase price, he opened an individual account as the fund family transferred the excess shares from his Roth IRA into the non-qualified account. In his case the fund had not reinvested any dividends or capital gains since his purchase so that was not a factor. If they had we would have simply had to transfer the shares purchased on reinvestment too.

From a tax perspective things are somewhat different. Now, any gains in the non-qualified account are fully taxable and not tax deferred. We lose some of the advantage, but not they underlying investment.

His accountant wanted him to remove his 2008 contribution too. But when he discovered how easy it is to adjust his contribution, he decided to wait a year and see what eligibility he ends up with for 2008. Even if he ends up ineligible for any contribution, his only penalty will be the taxes due on the income and growth accrued.

My Fountain Runneth Over by Vox Efx

   

Comments

[jodi kelsch]

What if his excess contribution actually declined in value.

[Art Dinkin]

Great question given the market conditions Jodi. In an up market, you remove the excess contribution and any associated earnings. With a down market you would remove the excess contribution less any associated losses.