Roth Excess Contribution

[Guest monicamn]

Last year under the advice of our investment person my husband and I converted our traditional IRAs to Roths. Find out this year that our MAGI was to high to except the total conversions. From some research it looks like we can accept up to 4000 each of the converted IRAs as a ROTH contribution and would only have to reconvert the excess of 4000 plus the earnings on this. Is this correct? Thanks for any help.

[John G]

Your post is mixing conversion and contribution information and your problem is complicated. You can get a better answer if you post the date of your conversion, your adjusted gross income for that year, your tax filing status (married filing jointly?), and if you made any contributions to either a IRA or Roth in that same year. Approximate age for both of you and your state of residence (is there an income tax?) would also be helpful. Have you already paid the taxes due on the conversion?

I am wondering if you are getting bad advice from your investment person. If this person offered advice on Roth conversions, he/she should have known the income limitation for a conversion. If you are married and filing jointly and can't do a conversion, you are in probably in a fairly high tax bracket. Generally, you do a conversion when you tax bracket is below what you expect it will be in the future. If you expect the same or higher tax bracket, a Roth conversion may not be in your best interest. Conversions scenarios are complex and must make many assumptions about your future income and the fed/state tax rates.

You don't want to mix up conversion eligibility with Roth contribution eligibility. If you did not meet the eligibility requirements for 2005 conversions, you will need to work with your custodian to reverse the transactions. If you were not eligible, you conversion attempt is essential a taxable withdrawal from your IRA, which might trigger a penalty and clearly has tax implications.

What you can and can not do is all in the details. Post again.

[Guest monicamn]

Thank you for your reply. The date of the conversion was 02/2005. MFJ with AGI over the Traditional to Roth Conversion limit and below the contribution limit. No contributions to a traditional IRA but $1000 to the Roth. The conversion amount was $4300 plus the contribution of $1000 putting me at $5310 year end balance. Can I just recharacterize the $1310 counting the $4000 as a contribution? I have not paid any taxes on the conversion. I am quite disappointed in the investment person but I just have to figure out what to do. Any help is appreciated. I have been trying to research this scenerio but I have not quite found an exact one. Some of the information on the internet is that a failed or ineligible conversion is treated as a regular distribution from the Traditional IRA and a contribution to the Roth IRA. This would mean only over $4000 needs to be recharacterized. I know it is a taxable event, I just don't want to be penalized for it. Does this option sound correct in what I should do?

[John G]

If you are not eligible to take IRA distributions without penalty - then the conversion would trigger both penalties and taxes and you surely want to get the custodian to send the money back to the IRA - recharacterization. If you are eligible for withdrawals due to age or other reason, then you can ask your custodian to treat it as a distribution to you and then a contribution. Depending upon the custodian, this will either be a one step or two step process.

Don't talk to someone who just answers the phone or is at the front desk. Ask to speak to the backroom IRA department. For example, at Schwab this dpt. is in San Francisco. The knowledge of local offices varies a lot and I would not depend upon the rookie who is often the first person you see.

Recharacterizing usually refers to unwinding a conversion - sending the money back to the original IRA. You still can make 2005 contributions to a Roth until April filing day of 2006. One or two step process depending upon how the custodian handles it. Note, if you send the money back for 2005 and then take a distribution in 2006 (step 2) your tax obligation would be for 2006.

A good lesson for all general readers. Know the rules. Choose an advisor wisely. Be wary of details - what may seem logical or simple to you may not follow IRS or custodian rules.