Correction of excess contribution w/o paying 6% penalty?

[Guest amfam2]

Please provide your opinion of the following excess correction method:

Customer puts in $3,280 in Trad IRA so far this year. Customer stops all future contributions. We know $280 is excess even though tax year is not over. Can we redesignate $280 as a contribution for 2004 without paying 6% tax penalty?

Here is my train of thought:

1. Tax code says one can redesignate the contribution for 2004, but customer would owe 6% penalty tax even if this decision is made prior to tax filing due date. (Essentially the customer would elect to leave the funds in the account).

2. Instead of leaving the $$ in, instead customer takes w/d of funds (knowing that they would owe taxes on earnings plus 10% penalty tax on earnings).

3. Customer gives financial instutution instructions to redeposit funds back into same IRA as contribution for 2004. Thus, the $295 withdrawal (the excess amt plus an assumed $15 in interest) would be redeposited as a $295 IRA contribution for 2004. Customer would receive 1099R representing w/d of excess.

The end result of 2, 3 & 4 above is that the customer has essentially elected to leave the funds in the plan and has circumvented the 6% penalty tax.

I wonder if the ability for a taxpayer to designate a contribution for a future tax year is only available to the taxpayer under excess contribution rules.

If the taxpayer is taking a withdrawal, rather than simply leaving the funds in the account, then they do not have the option of instructing the financial institution to earmark the redeposit as a 2004 contribution if we are not in the 2004 tax year at the time the transaction is processed.

I am interested in everyone's thoughts on this....

[Guest Fishchick]

I think this is fine if it is completed in 2004. It's basically asking the custodian/trustee to recontribute the $ instead of asking the client to receive a check, then make another separate contribution. It's still a timely correction, so I don't really see this as "circumventing" the 6% penalty. Remember, that the client would still owe taxes and penalties on any earnings that were removed as well. Sometimes it's helpful to run the numbers both ways to determine which is costlier. Given your example, a customer in a 25% tax bracket, who had earned 25% in the account since making the excess contribution, would have to remove $350, and pay taxes of $17.50 plus penalty of $7.00, versus the 6% penalty of $16.80. Sometimes, it's more cost effective to leave the money in the account- when the market is strong of course.

[WDIK]

I want Fishchick managing my investment portfolio.

[Guest Fishchick]

Well, I made 28% YTD in my 401k, but that barely began to makeup for my losses in the past few years.