Fix excess Roth IRA contribution 2020: using both recharacterization AND timely removing excess before tax filing

[bareli]

Hi,

I contributed $6000 at the beginning of 2020.  However, throughout the year, the extra income I have earned made it no longer eligible for me to contribute anything for 2020.  According to the IRS formula, the amount ( initial contribution + income) that I need to remove is greater than $6000.

For example, if the amount I needed to remove from the ROTH IRA to avoid the 6% penalty is $6500, can I first recharactorize $6000 to traditional IRA, then remove the $500 as a distribution and pay the 10% early distribution penalty on the $500?

If that's not possible, is the timely removal of the excess before the tax filing my best option?

Also,  regarding the formula to calculate net income (see below), what date should I use for "adjusted closing balance"? should it be 12/31/2020?

Excess contribution * [(adjusted closing balance - adjusted opening balance) / adjusted opening balance ]

Thank you very much!

[DanaB27 · Accepted solution]

You will need to request a recharacterization with your bank by the due date of your return. They will move the contribution and earnings into a traditional IRA.  There is no tax or penalty on the earnings since the earning will be simply switched into the recharacterized account. You will receive a 1099-R for the recharacterization.

Please follow these steps to enter your contribution:

1. Login to your TurboTax Account 
2. Click on the Search box on the top and type “IRA contributions”
3. Click on “Jump to IRA contributions"
4. Answer "yes" to "Switch from a Roth To a Traditional IRA?".
5. The $6,000 of the original Roth contribution must be entered - not any earnings or losses.
6. Then TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.

[dmertz]

If you are considering recharacterizing, it doesn't seem to make much sense not to just recharacterize the entire excess contribution.  If you contributed $6,000, you recharacterize $6,000 and the $6,000 adjusted for any attributable investment gain or loss is transferred to to the traditional IRA.  If the gain is $500, you still just recharacterize $6,000 and $6,500 is transferred.

But to answer the question that was asked, yes, you can do a combination of recharacterizing and return of contribution.  The order in which you perform these and and how you split the excess between recharacterizing and return of contribution don't matter (except perhaps for slight differences that would result from investment gain or loss incurred between these two transactions, if any).

[bareli]

Thank you. I misunderstood that the recharacterized amount needs to be equal to or less than the contribution limit ($6000 in this case).  I will just recharacterize the whole thing instead of recharacterizing and then doing the distribution. 

[bareli]

thank you very much!

[dmertz]

The amount of contribution to be recharacterized (the unadjusted amount) must be less than or equal to the amount contributed, the amount that must be transferred to effect that recharacterization might not be.  Unless there was no gain or loss, the amount that must be transferred will be greater or less than the amount recharacterized.  When TurboTax asks how much was recharacterized, TurboTax is not asking how much was transferred.

[bareli]

Thank for the explanation. 

so in my example

contribution to Roth ira 2020: $6000

actual contribution allowed in 2020: $0 (due to the extra income received in the latter part of 2020)

net income from the excess contribution: $500

So I should recharacterize only the contribution of $6000, and transfer $6500 from Roth ira to a traditional ira?

is my understanding correct? 

Thank you so much. 

[dmertz]

Generally the IRA custodian does the net-income-attributable calculation and the IRA custodian needs to do the transfer so that it's reported correctly on Form 1099-R.  You should not do it yourself other than doing the calculation yourself to verify that the IRA custodian did the correct calculation.

[SLYKTAX]

I am in the same boat as bareli as extra payout made me not eligible to contribute to my ROTH IRA but both my wife and I have contributed $7000 each at the beginning of the year.   I also contributed $7,000 for 2021.   Now I need to remove $21,000 from our accounts.   I am trying to contact Charles Schwab to initiate withdrawal.  What other  steps should I do now?  Please advise.

[DanaB27]

Yes, you will need to contact to either withdraw the excess contribution plus earnings or to recharacterize the contribution before the due date.  Please see What happens if I made a ROTH IRA contribution but my modified adjusted gross income exceeds the lim... for details.

@SLYKTAX

[cjax55]

I had to recharacterize contributions from Roth to Traditional due to limitations.  I followed TurboTax prompts, entering as Roth and providing info from 1099R.  I am not seeing TurboTax treat these as deductible contributions to a traditional IRA.  Are these recharacterized contributions tax deductible, even if I take the standard deduction?  If so, where would they show up?  Thank you.

[DanaB27]

It depends, the deduction to a traditional IRA may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. Please see IRA deduction limits for details. If it is deductible it will show on Schedule 1, line 19.

You will enter the recharacterization when you enter the contribution to the Roth IRA

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “IRA contributions”
3. Click on “Jump to IRA contributions"
4. Select “Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution
6. Enter the Roth contribution amount 
7. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount (no earnings or losses)
8. TurboTax will ask for an explanation statement where it should be stated that the original $xxx.xx plus $xxx.xx earnings (or loss) were recharacterized.
9. On the screen "Choose Not to Deduct IRA Contributions" answer "No" (Answer "yes" if you are thinking about doing a backdoor Roth. If you have a retirement plan at work and are over the income limit it will be nondeductible and you only get a screen saying $0 is deductible)

@cjax55

[cjax55]

THanks for the quick response.  I'm single and do not have a retirement plan with my employer.  I originally made the contribution as a Roth IRA but due to wage limits, had to recharacterize it as Traditional.  My understanding is that the traditional would be deductible but I'm not seeing that applied in Turbo Tax.  Is there any other reason TT would make it non-deductible?  I was thinking it should now be entered as Traditional but the note in TT says NOT to include recharacterized contributions and instead, list them as Roth.  Still confused :(

[kvkeee]

Dear @DanaB27 

I am in the same boat as @bareli and I filled the recharacterization as you (@DanaB27) described above . You mentioned we will be getting a 1099-R, I assume it will be in 2022.

Do I have to amend my 2020 return next year (in 2022) or simply ignore the 1099-R.

Or do I have to report it in my 2021 returns, because the transaction occurred in 2021?

Thank you in advance.

[DanaB27]

Please check Schedule 1, line 19 if it shows the deduction. When you enter the recharacterization do you get the question in step 9 (see above)? Or do you only get a screen saying $0 is deductible? 

If not then please double check your W-2 that the box 13 retirement plan is not checked:

1. Login to your TurboTax Account 
2. Click on "Search" on the top right and type “W-2”
3. Click on “Jump to W-2”

@cjax55