Question about calculating "earnings" on excess of contributions to IRA

[xilex]

Hello, I have an issue with excess of contributions to an IRA. Can you let me understand if I have these calculations correct.

Assume, I have a total of $11,000 of excess contributions to Roth IRA, with account balance starting at $0. There was one deposit of $10,000 and a later $5,000 deposit (all after-tax money; it is from Roth 401k). Assuming no other appreciation/growth/etc. I am using the Net Income Attributable formula (I think this is the right formula to use?), one example here: https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning....

So my starting account balance is $10,000, and the ending balance is $15,000. That means I have to pay taxes on 11000 * (15000-10000)/10000 = 5500. So if I am doing this correctly, I am paying another $5,500 of taxes (despite zero actual growth since it is all from contributions)? If so, is this tough luck, don't do this again in the future? Thanks.

[NCperson]

@xilex - is this excess from 2021 or 2022 tax year?

[xilex]

Sorry, neglected to mention that. This is excess for 2022 year. And the limit I refer to is the $61,000 from employer/employee contributions to a 401k plan.

[NCperson]

@xilex - then I am confused by your ask - look at #1 in the link you provided 

1. Timely remove excess before the tax filing deadline
— The excess or unwanted IRA contribution amount,
plus the net gain or loss, will need to be removed by the tax
filing deadline (generally April 15), including an automatic
six month extension. This means the excess should
generally be distributed by October 15. If you remove the
excess contribution after you file your taxes, you may need
to file an amended tax return. If you remove the excess in
a timely manner, you will owe tax and, if under age 59½,
the IRS 10% additional tax for early or pre-59½ distributions
(10% additional tax) on any earnings, not on the excess
contribution. See the next page for the IRS provided
formula for calculating the Net Income Attributable (NIA)
of either earnings or losses.

[dmertz]

You are calculating incorrectly.  Your Adjusted Opening Balance is $15,000, not $10,000.

[xilex]

Why would it be $15,000? Because on the date of the first overcontribution it is $10,000.

@NCperson 

My issue is they (broker, Fidelity in this case) have computed a positive earnings based on the formula. On the first date of excess contribution, the account balance was $10,000 (w/the contribution), and then there was another $5,000 contribution. Then on the date of return of excess contribution the account balance was $15,000. So based on NIA formula, I end up having earnings because this account has gained $5,000 overall. Am I incorrect?

[dmertz]

Read the definition of AOB in the reference you provided or in CFR 1.408-11.  The $5,000 deposited later, but prior to the return of contribution, must be added to the $10,000 originally contributed.  By not accounting for that $5,000 in the AOB, the $5,000 is treated as investment gain (which it is not).

[xilex]

Thanks, @dmertz , for pointing that out 😁 I looked at your IRS link, and the second example they provided with multiple contributions. That makes more sense to me. I'll have to call Fidelity next week to figure this out. I don't believe they are including the second $5,000 contribution in AOB.

[Critter-3]

Did you roll funds already contributed into a  ROTH 401K  to a ROTH IRA?  If so the roll is not a contribution at all.  There is no way an IRA custodian would have allowed an excess contribution of 15K for the same tax year & if they did you need to fire them. 

[dmertz]

My replies address only the method for calculating the attributable net income, not how $11,000 of excess Roth IRA contribution came to be.  It's true that it's not clear where an $11,000 excess contribution would have come from.  I've been operating under the assumption that these were somehow distributions from the Roth 401(k) contributions that were not eligible for rollover to the Roth IRA, but were inadvertently rolled over, or that the excess came from some entirely separate transaction(s).

[xilex]

@Critter-3 and @dmertz 

Maybe I have my terminology incorrect. My employer offers a 401a as one of its retirement accounts. This account includes mandatory pre-tax contribution (w/employer match), but also voluntary after-tax contributions. I have been rolling these after-tax contributions to Roth IRA. I thought my after-tax would be capped after it reaches the IRS limit (61k in 2022), but it did not. It was my last paycheck of the year, so these were the final numbers for all contributions. So now I have this excess money in Roth IRA. And after speaking with Fidelity, they instructed me to do the return of excess contributions form.

[dmertz]

That makes sense.  Since the excess after-tax (not Roth) contributions to the 401(k) were not eligible for rollover, they must be treated as regular contributions to the Roth IRA rather than rollover contributions and removed from the Roth IRA by return of contribution.

[xilex]

Would it be better to leave it in 401k account next year and withdraw overcontribution that way?

[dmertz]

The distribution from the 401(k) that was rolled over to the Roth IRA has already removed the excess from the 401(k) and placed it in the Roth IRA.  It has to be returned from the Roth IRA.