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I'm dealing with correcting an overcontribution to a Roth IRA due to income limits, and my head hurts. Here's the gist of my problem.

I contributed $5500 to my Roth in 2016. In March 2017, I went to file my taxes and discover based on my MAGI of $126K, I could only contribute $2200. Ok, no problem. I call my account holder, explain that I've over-contributed for 2016, and have them remove $3300 plus earnings. Now I just have to deal with the 10% early distribution on the earnings, right? I know I'll get a 1099-R and deal with it when it arrives.

Not so fast! In March 2018 (one year later), I receive my 1099-R, and find out when I go to enter it, that the earnings were taxable on my 2016 taxes, filed in 2017. The market was good and my earnings were $1000. So now my MAGI for 2016 is $127K, and my Roth limit was actually $1833. Despite trying to fix everything, I overcontributed by $367 in 2016 (not to mention I have to amend my 2016 taxes to pay the taxes on the earnings).

Obviously this settles eventually and had I known the earnings on an excess distribution were due in the year of contributions, I could have stopped the game by withdrawing sufficiently enough to offset the contribution limit change from the increased MAGI, but is this really how it works? I hope I'm missing something.

  • 2
    If it's any comfort, there's a similar feedback between the above-the-line deduction for health insurance for self-employed and the AGI-dependent ACA (aka Obamacare) Premium Tax Credit that takes 16 pages in pub 974. Okay, probably not much comfort :( – dave_thompson_085 Mar 19 '18 at 1:40
  • You can't recharacterize the contribution to a non-deductible IRA anymore? (which at least defers tax on the income, eliminating the convergent series ... and if you find yourself in a low-income year in the future, you can convert it to a Roth) – user662852 Mar 19 '18 at 15:52
  • You need to provide more details in your question. You say (in early March) that you contributed to your Roth IRA this year (2018). But was this contribution for 2018, or for 2017? Because in March 2018, you will be working in your 2017 taxes, and your AGI for 2017 is irrelevant if your Roth contribution was for 2018. If it is a 2017 contribution, you can back out any excess contribution (and earnings) before April 16 and it is as if you never made the excess contribution at all, and it does not affect your AGI or MAGI for 2017. You do owe 2018 taxes on the earnings, but no 10% penalty ..... – Dilip Sarwate Mar 19 '18 at 21:03
  • ---- provided you told the IRA custodian very clearly what you were doing -- backing out an excess 2017 contribution and the earnings thereon in timely fashion -- and not just said "Send me $2570+600" which would be an early withdrawal. But even here, you might be able to avoid the penalty because withdrawals from Roth IRAs are of contributions first and earnings last, and withdrawal of contributions is tax-free and penalty-free. – Dilip Sarwate Mar 19 '18 at 21:10
  • @user662852 - unfortunately, no, as the time for that has already passed. I'll update the questions to make the dates clearer. – aggieTaxes Mar 24 '18 at 3:11
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I found a forum post on the Intuit website that confirmed what I learned here and in some other places. Thanks all for the feedback and input.

The gist of it is:

  • Yes, the earnings on the withdrawn amount count towards MAGI, further reducing your contribution limit
  • You could repeatedly withdraw (given enough time before you file taxes) until it settles, or withdraw enough to make sure you are under the limit even after your new earnings are factored in
  • You could withdraw the entire amount (before you file taxes)
  • You could recharacterize as a regular IRA. Some or all of this may not be deductible, but it means you don't have sudden new earnings plus penalty on them
  • If your earnings are huge (e.g. bigger than your contributions), it may make sense to wait to withdraw the overcontribution and pay a 6% penalty on the overcontribution for at least the two years the extra money has stayed in the account. This is because when you withdraw excess post-contribution period, you only have to withdraw the contribution, not the earnings, which can remain forever. And 10% of your earnings could be more than 12% of your contribution.

The overall lesson for me is that being in the phase-out range for the Roth is a nightmare. Once you find yourself anywhere near the Roth phase-out range, don't even bother contributing any amount. All it takes is discovering a small mistake on your taxes a few years after filing to end up with a new MAGI, sudden overcontribution that has been present for years, and having to refile for every tax year between the overcontribution and when you discover the mistake.

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I can't quite tell what happened here. But if you take the money out before the tax date (april 15th) you shouldn't have to pay a penalty. If you didn't take it out before tax time you have to pay 6% on the overage each year until you fix the problem.

And if you made a profit, that profit should be applied to next year's taxes. You should get a 1099 form from your broker at the end of the year.

I can't quite tell if the 10% penalty still applies but even if it does it should be minimal. It is 10% of any gains not the overage.

Sources: https://investor.vanguard.com/ira/excess-contribution

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

And as @Dilip Sarwate mentioned you should discuss this with your broker if you havn't already.

  • Unfortunately the profit is applied to the taxes of the year in which the contributions were made, not when the excess was removed. From page 17 of the 1099-R guide, "The IRS suggests that [the broker] ... advise payees ... that the earnings are taxable in the year in which the contributions were made." See irs.gov/pub/irs-pdf/i1099r.pdf. How I wish Vanguard would have done that and saved me the headaches I'm encountering this year. – aggieTaxes Mar 24 '18 at 3:10
  • @agieTaxes You might be right for an IRA. See "Excess Contributions" section of this publication: irs.gov/publications/p590a#en_US_2017_publink1000230873 I would make sure I overpaid my taxes and file an extension. Honestly it will probably end up costing you a couple hundred bucks. Not great but not the end of the world. – kweinert Mar 27 '18 at 0:40

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