Contributing to Roth IRA during the Tax Year and Things to Be Aware Of?

[starkyfubbs]

I have always contributed to my Roth IRA after the tax year has ended (e.g. 2021 contribution to Roth in February 2022). At that time, I am certain I am not over the MAGI (Modified Adjusted Gross Income), and am eligible to make a Roth contribution. 

For this current year, I am thinking about making my 2022 Roth IRA contribution earlier (e.g. in the next few months), and putting that money into stocks. I am pretty certain I will not be over the MAGI for 2022, barring any unforeseen circumstance.

But if for some reason, I suddenly become over the MAGI, what are the steps to take and tax implications I should be aware of? I am assuming I would need to withdraw/take distribution of my 2022 contribution amount, and possibly pay taxes on any gains. How does the IRS determine if gains were made from pre-2022 contributions or not? What if there are losses?

Thank you.

[dmertz · Accepted solution]

If your MAGI ends up being high enough that any part of your Roth IRA contribution becomes an excess contribution, you'll resolve that by asking the IRA custodian either to recharacterize the contribution to be a traditional IRA contribution instead, possibly nondeductible, or to make an explicit  return of contribution, not a regular distribution.  If you obtain a return of contribution, any gain is taxable and potentially subject to an early-distribution penalty depending on your age.  The gain is calculated over your entire account balance from the time of the contribution to the time of the return of contribution.  The calculation does not depend on the performance of any particular investment in the IRA (unless you have only one investment).

If there are losses there will not be any taxable gain.  You can't use the losses to offset any other income, the  adjusted amount of the distribution will simply be less than the amount of contribution being returned.

CFR 1.408-11 describes the calculation in detail:  https://www.law.cornell.edu/cfr/text/26/1.408-11

[starkyfubbs]

Thank you @dmertz for the explanation and link outlying the calculations. It is good to be aware of this.