Excess ROTH contribution recharacterization

[aglow]

In Oct of 2022 I realized that my wife and I would be over the income limit for the ROTH we were contributing to, so I contacted Vanguard and had a recharacterization done into a traditional IRA. We had contributed $4600 at that point, but because of market losses the amount put into the traditional IRA was $3572. 

I just called Vanguard to get help with getting all of this information and entered it into Turbotax, so now my return is showing the amount that was recharacterized as a $4600 traditional IRA contribution. 

My question is based on something the Vanguard rep told me. She had advised me that I may want to put the money that I recharacterized into the traditional IRA back into the ROTH via the backdoor method. And apparently if I didn't do that, it would cause issues going forward of me having to track that amount manually year after year.

I didn't totally understand this and I'm wondering if anyone can shed some light on if just leaving it in the traditional IRA would cause some kind of problem going forward. I've looked online and through these forums and I couldn't really find anything indicating that this would be a problem. I don't want to convert it back to a ROTH if that is going to make things more complicated either. It's not a particularly large amount of money, so I'm content to just do whatever is the easiest, less complicated thing to do. 

Thanks in advance for any help you can provide.  

[DanaB27]

No, leaving the contribution in the traditional IRA won't cause any problems. If the contribution is nondeductible because of your income and retirement plan at work, you will keep track of your basis on Form 8606. When you take a distribution it will be important to enter the basis because then part of your distribution will be non-taxable.

A benefit of moving it to a Roth IRA would be that the earnings won't be taxable when you later take Qualified Distributions. The traditional IRA distribution will be taxable except for the part that is allocated to the basis (if you make nondeductible traditional IRA contributions).

A backdoor Roth will only work successfully if all of your traditional/SEP/SIMPLE IRAs don't have any pre-tax funds (deductible funds). If you have pre-tax funds in your traditional/SEP/SIMPLE IRAs then the pro-rata rule applies. 

Please review the steps to enter your recharacterization into TurboTax:

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 "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 automatically and you only get a warning and then a screen saying $0 is deductible)

[aglow]

Thank you for the info, I still can't figure out how to get all of this into Turbotax. 

I would like to recharacterize it again as a ROTH as I do not want to have to track it year after year. I did this via Vanguard just now and I can't get it properly into Turbotax.

To summarize, I contributed $4600 to a ROTH throughout the first 10 months of 2022. In Oct, I opened a traditional IRA with $100 recharacterized $3572 (which is the full $4600, adjusted for market loss) into that IRA. Now I have recharacterized $3888 from the traditional back into the ROTH (which is the full amount in the account, adjusted for market gain).

Turbotax's desktop software is saying that I made an excess contribution of $3672. So either I don't know how to input it correctly or I'm not understanding how this works.

I absolutely do not want to have to track the basis for what is in an IRA over years. Vanguard doesn't do this for me and it's not something that I want to deal with. Am I understanding this process correctly? How should I proceed?

[DanaB27 · Accepted solution]

Please be aware, for a backdoor Roth you want to make a conversion and not a recharacterization. Please verify that you selected conversion for moving the funds from the traditional IRA to Roth IRA.

If you recharacterized the traditional IRA contribution as a Roth IRA contribution then you will again have issues with excess contribution because of your MAGI limit.

Assuming you selected correctly conversion, you will first enter the $100 direct contribution to the traditional IRA and the recharacterization from Roth to traditional IRA on your 2022 tax return:

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 “traditional IRA" and "Roth IRA”
5. Answer “No” to “Is This a Repayment of a Retirement Distribution
6. Enter the traditional IRA contribution amount of $100
7. Answer “No” to the recharacterized question on the “Did You Change Your Mind?”
8. Answer “No” to “Is This a Repayment of a Retirement Distribution
9. Enter the Roth contribution amount of $4,600
10. Answer “Yes” to the recharacterized question on the “Did You Change Your Mind?” screen and enter the contribution amount of $4,600 (no earnings or losses)
11. TurboTax will ask for an explanation statement where it should be stated that the original $3,572 minus $1,028 loss were recharacterized.
12. On the screen "Choose Not to Deduct IRA Contributions" 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 automatically and you only get a warning and then a screen saying $0 is deductible)

You will have the 2022 Form 8606 with the basis on line 14. TurboTax will automatically carry it over to the next year.

Then next year you will get Form 1099-R for the conversion and since it happened in 2023 it will belong on your 2023 tax return next year when you file:

1. Click on "Search" on the top right and type “1099-R”  
2. Click on “Jump to 1099-R”
3. Click "Continue" and enter the information from your 1099-R
4. Answer questions until you get to “Tell us if you moved the money through a rollover or conversion” and choose “I converted some or all of it to a Roth IRA”
5. On the "Review your 1099-R info" screen click "Continue"
6. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years.
7. Answer the questions about the basis from line 14 of your 2021 Form 8606 and the value of all traditional, SEP, and SIMPLE IRAs

Please see What's the difference between a conversion and a recharacterization? for additional information.

@aglow