What if contribute too much into IRA accounts

[VAer]

Just making an example,

Assumption: In July 2020, I contributed $1000 in traditional IRA for year 2020 & $5000 in Roth IRA 2020, at that point, my income allows me to contribute up to $6000.

But for individual brokerage account: if I sell some stock in December 2020 and claim capital gain for year 2020, which will actually cause me not qualified for IRA contribution.

Above assumption applies to both below two cases:

1) IRA accounts also have capital gain, what will happen to the IRA accounts (I actually should not contribute due to income limit, but I have already made the contribution in July)?

2) Both IRA accounts lost money or lost all the money (wiped out when option trading), what will happen to the IRA accounts? I should not contribute to IRA in July but I have already made the contribution, but I cannot take any money out of IRA since I lost everything in IRA accounts.

Thanks.

[fanfare]

You can work off your "excess" by ensuring that your Contribution next year is less than the max allowable,
particularly by the amount of your excess. Then your penalty situation will be resolved, using Form 5329.
if you are eligible next year to contribute 6000, or (some amount) you can apply that amount to resolving your excess and you don't have to take the 6000 out. see Form 5329.

[VAer]

What happen if I never have chance to make Roth IRA contribution anymore? E.g. I will be promoted and salary is increased a lot, OR brokerage account becomes big & I expect some capital gain from stock market every year, make me unqualified for Roth IRA contribution anymore

[fanfare]

put another 6000 into your IRA, even if not allowed, and do better trading. get your $account up to 12,000+penalty and then you can remove the excess

[fanfare]

Of course the above must be taken as somewhat facetious since you'd be throwing good money after bad. If you can't repair your trading strategy you will be twice as deep in the hole.

[fanfare]

If you close your Roth IRA any excess contribution penalty should dissolve also. Right, @dmertz   ?

[dmertz · Accepted solution]

Depends on whether or not this Roth IRA is the only Roth IRA.  If this is the only Roth IRA, it is entirely distributed and it has lost value since relative to that immediately after making the contribution, there would be excess contribution penalty since the penalty is based on the lesser of the amount of the excess contribution and the year-end balance in Roth IRAs.

To resolve the excess contribution properly, you could as the Roth IRA custodian to recharacterize the Roth IRA contribution to be a traditional IRA contribution instead, resulting in the custodian transferring to a traditional IRA the the amount of the contribution adjusted for investment losses, or by requesting a return of contribution from the Roth IRA, resulting in the loss-adjusted amount being distributed to you without any penalty (since there are no taxable gains attributable to the contribution).

If the Roth IRA currently has a $0 value, a recharacterization would accomplish nothing, but a return of contribution would make sense with a loss-adjusted distribution of $0 reported on a code J8 2020 Form 1099-R if done in 2020.

I'm not sure how a Roth IRA with a $0 value could receive any capital gains.  The investment performance must be calculated over the entire Roth IRA, so if the Roth IRA does not have a $0 value because the value include more than what was attributable to the $5,000 contribution for 2020, the recharacterization or return of contribution could have either a gain or loss depending on overall investment performance.

Contributing more makes no sense at all.

[VAer]

"I'm not sure how a Roth IRA with a $0 value could receive any capital gains"

Those are two separate scenario, two separate questions.

1) In July 2020, made $5000 to Roth IRA & $1000 to traditional IRA, at that point, I was qualified for making the contribution. In December 2020, sold some stock (Individual Brokerage account) and cause me actually not qualified for any contribution. And Roth IRA & Traditional IRA also have capital gain by the end of 2020, and how to resolve the excess contribution? 

2) In July 2020, made $5000 to Roth IRA & $1000 to traditional IRA, at that point, I was qualified for making the contribution. In December 2020, sold some stock (Individual Brokerage account) and cause me actually not qualified for any contribution. And Roth IRA & Traditional IRA are almost wiped out by the end of 2020 (assuming no more than $10 balance), how to resolve the excess contribution? Moreover, from 2020 on, I am probably not qualified for making Roth IRA contribution anymore.

[dmertz]

Either way, the distribution from the Roth IRA either as a recharacterization or a return of contribution involves a distribution from the Roth IRA adjusted for investment performance as I described.  The adjusted amount is generally calculated by the IRA custodian, using the method described in CFR 1.408-11.

[VAer]

Thanks. Although I don't quite understand now, I will do some search in the next few days. Thanks for the information.