Roth IRA Excess Contributions

[Guest minerj6]

I got an unexpected bonus this year that will put me well above the $95,000 max for contributing the full $4000 to a Roth IRA, but I have already contributed $3200, more than will be allowed. The best remedy that I think is available and legal, according to the 2004 IRS Form 590 (page 57 and 58) http://www.irs.gov/pub/irs-pdf/p590.pdf, is to withdraw the excess contributions and associated net earnings before April 15, 2006 and pay tax on the earnings as regular income for 2005. By withdrawing before April 15, "the contributions are treated as if never made them" according to 590.

Basically, this rule would seem to allow anyone who contributes to a Roth IRA during a year to decide the following April 14 that they need to liquidate, and as long as contributions and all earnings are redeemed, and regular income tax is paid on the earnings, there is no penalty.

The problem is, my mutual fund firm won't acknowledge this rule and says I will have to pay a 10% penalty on the earnings because I am not 59 1/2 but am making a withdrawal. I am worried that even if I am right, how they characterize the withdrawal could impact how the IRS views the transaction.

Any comments? Thanks.

[John G]

Over funding of a Roth is not a rare occurance, and a mutual fund or brokerage should know how to handle the paperwork.

I suspect that you are talking with a minimally trained clerk. Call the mutual fund again, but this time ask to speak to the IRA/Roth department. If you still have a problem. Post again and provide the name of the mutual fund.

[Guest worryfreeinvestor]

I have the same challenge with Fidelity. On January 3, 2006 I made contributions for both my wife's and my Roth IRA and a few days later we recalled that she was planning to get a job this year, putting us well over the AGI limit for Roth IRA contributions for "married, filing jointly" persons! We are just too anxious to put our money to work!

Anyway, I e-mailed Fidelity and the response stated: "Withdraw the contribution as an excess contribution. You can request the removal of the contribution by completing our IRA Return of Excess Contributions form which is also available online.

http://personal.fidelity.com/accounts/serv...rawal.html.tvsr

Any earnings removed from the contribution will also be subject to tax at your ordinary income tax rate along with a 10% early withdrawal penalty. The penalty is reported by filing the IRS 5329 tax form."

I had made it clear to Fidelity that I was proposing withdrawing a 2006 contribution in 2006. I shall feedback your information to them (which seems absolutely correct to me) and post again as the dialogue develops.

[Guest mjb]

Fidelity is correct. Earnings on an excess IRA contribution which are returned by 4/15 are taxable income subject to the 10% penalty on premature withdrawals. Only the return of the contribution is not subject to the 10% penalty tax. See IRS publication 590, P 46. Under IRC 409A(a) a Roth IRA shall be treated in the same manner as an IRA unless there is an exception in 409A. 409A does not provide for an exception in the 10% penalty for earnings on excess Roth contributions which are withdrawn by 4/15.

[John G]

Earnings in just a few days? If we are talking about this Janauary... a timely correction should minimize the issue.

[Guest minerj6]

Dear mjb,

Thanks for the information. I will plan on paying up to the IRS. 10% won't kill me.

minerj6

[Appleby]

Of course, there is always the option of recharacterizing the amount to your traditional IRA.

By the way, if you file your tax return by April 15 ( April 17 this year , as April 15 falls on a Saturday), you have until October 15,2006 to remove the excess amount and avoid the 6% excise tax or to recharacterize the amount to a Traditional IRA

By recharacterizing, you treat the amount as a Traditional IRA contribution and –if eligible- could claim a tax deduction for the amount.