IRA contribution not tax deductible because AGI is over the limit

[MJ2404]

I didn't know about this rule when I made a contribution to my IRA but I'm wondering if IRS will charge me 10% early withdrawal penalty if I withdraw the money back to my savings account?

[DanaB27]

No, won't get a withdrawal penalty on the withdrawn contributions.  

If you made a contribution to your IRA, either traditional or Roth, you can withdraw that contribution tax-free and penalty-free if you do so by the due date of your return. You need to request a return of the contribution with your financial institute.

[Edited 1/31/2021 | 8:19am PST]

[dmertz · Accepted solution]

The answer is "it depends."  A regular distribution made now would be subject to reporting on a 2021 Form 8606 to determine the taxable amount of the distribution and the taxable amount would be subject to an early-distribution penalty on your 2021 tax return.

To avoid all of that, you would explicitly request a "return of contribution," not a regular distribution.  The distribution of a return of contribution is required to be accompanied by any investment gain or loss in the IRA while the money was in the account.  If there is a gain, the gain will be subject to tax and an early-distribution penalty on your 2020 tax return.

If your modified AGI for the purpose allows you to be eligible to make a Roth IRA contribution you could recharacterize the contribution to be a Roth IRA contribution instead.

Even though you do not get a deduction now for the traditional IRA contribution, you are still saving for retirement if you leave the contribution in, the primary reason for contributing to an IRA.  This money will not get taxed twice.

[MJ2404]

Im not eligible for ROTH IRA.  My 2020 AGI is more than $220K.  

Can we do the “return of contribution” via the 2020 TurboTax software?  I would rather  wire back the money back to my savings account and reinvest it somewhere else.  

[dmertz]

You can request the IRA custodian to make a "return of contribution."  They'll have a special form for requesting this type of distribution.  If you instead make a regular distribution, the amount that is taxable and subject to an early-distribution penalty will depend on how much you have in total in traditional IRAs.

[MJ2404]

Can I transfer the money now back to my savings account while waiting for the IRA custodian to make the “return of contribution” form?  Or should I wait for them to make the form first?  

[dmertz]

If you want to do a return of contribution, the custodian must initiate the funds transfer.  If you initiate the transfer yourself, say, with an online transfer request,  the result will be a regular distribution, not a return of contribution.