Excess Contributions for 401+ IRA

[GreenCloud]

I contributed 6000 to my Traditional IRA in Jan 2021. In the Middle of the Year, my employer introduced 401K and I started contributing to it as well and I will reach the 19,500 limits for 2021.
I make more income so that I cannot deduct both 401K and IRA.

Do I need to withdraw the 6000 from the Traditional IRA? If so it's all invested in stocks and how can this be withdrawn with Minimum Taxes?
Can I also leave this in my Traditional IRA as a Non-Deductible contribution and don't any anything? Please suggest a better way to handle this. Thanks in Advance.

[Opus 17]

You don't say what your income is.  Is it high enough that you are also disqualified from making Roth IRA contributions, or are you only disqualified from traditional IRA contributions?  The limits vary by family type and income. 

https://www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2021

[GreenCloud]

Thanks for responding . 

Married, filing jointly with an income of 140K.  I may qualify for contributing to Roth IRA. My question is around withdrawing or keeping the money this year's contribution from the Traditional IRA.

[Opus 17 · Accepted solution]

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@GreenCloud wrote:

Thanks for responding . 

Married, filing jointly with an income of 140K.  I may qualify for contributing to Roth IRA. My question is around withdrawing or keeping the money this year's contribution from the Traditional IRA.

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You can "cancel" or reverse the IRA contribution by contacting the bank.  This is not a normal withdrawal, you probably need to send them a special form.  You will have to remove both the excess contribution and any earnings.  Your deadline to do this is the tax filing deadline (normally, April 15, 2022).  If you withdraw the excess and the earnings in 2021, the money will be added back to your taxable income (you don't take the deduction) and the earnings will be taxable in 2021.  If you waited until after January to withdraw the excess contributions, you would still pay the tax in 2021 (because you don't take a deduction) but the earnings would be taxed on your 2022 return (if they weren't withdrawn until 2022).

Based on your income, you have a second option.  You may "recharacterize" your IRA contribution as a Roth IRA contribution.  You don't get the tax deduction this year, but you do get the benefit of leaving the money in a retirement account for the long term, and you don't pay taxes when you withdraw the money after reaching age 59-1/2.   If you recharacterize the contribution as a Roth IRA, you leave the earnings in the Roth account and they are not taxed either. The deadline to recharacterize your contributions is also the tax filing deadline.

Whether you withdraw or recharacterize the money depends on your financial need and how much you want to save.  If you don't need the money, you may want to leave it as a Roth IRA.  If you leave it in the traditional (deductible) IRA, the IRS will eventually assess tax and a penalty, so you will want to fix this one way or the other.

Finally, at your income level, your spouse may also contribute to a Roth IRA in their name, even if they don't work (they can rely on your earnings to make a contribution into an account in their name).  There are no "joint" IRA accounts, each account is owned by a single individual.  But your spouse can make "spousal IRA" contributions in their name even if they don't work, as a way of increasing your overall savings potential. 

[GreenCloud]

Thank you sir for providing a solution.

 I did go through the steps in Vanguard to explore this option now.

If I decide to recharacterize the contribution of 6000 to Roth IRA, do I need to move the exact stocks which were bought using that 6000 and move it to Roth IRA? Do I need to sell the stocks and then move the move them to Roth?

[Opus 17]

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@GreenCloud wrote:

Thank you sir for providing a solution.

 I did go through the steps in Vanguard to explore this option now.

If I decide to recharacterize the contribution of 6000 to Roth IRA, do I need to move the exact stocks which were bought using that 6000 and move it to Roth IRA? Do I need to sell the stocks and then move the move them to Roth?

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You'll have to ask Vanguard.  The individual securities can be moved without selling them, but it seems unlikely that would add up to exactly $6000 (or whatever amount needs to be moved).  I suspect that if you just ask Vanguard do a recharacterization, they will sell the correct amount, move it as cash, and then re-buy the same securities (or different ones if you prefer).  I suspect Vanguard will do this for you rather than you having to do all the small in-between steps.  But ask them. 

[GreenCloud]

Thanks and I appreciate your help.