Move overfunded Roth IRA to next year or remove excess this year?

[Drfreud]

I am currently 58 1/2.  If I withdraw an excess contribution for 2020 prior to April 15, 2021, I understand that I will owe a 10% penalty on the earnings.  If I leave the money in the account, I will owe a 6% penalty on the amount that is overfunded.  IRS document 590-A says:

"Applying excess contributions.

If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in 1 year to a later year if the contributions for that later year are less than the maximum allowed for that year."

The financial institution that has my Roth IRA says they don't report anything beyond the initial funding.

1) How does one report that a contribution in 2020 will be applied to 2021 in TurboTax?  

2) If I do this, do I still pay the 6% penalty in 2020?

3) If I take the 6% hit today and hit another limit in 2021 and subsequently remove the amount funded and any earnings in 2022, I would avoid the 10% penalty on earnings since I will be over 59 1/2 and just have to pay the normal tax rate on earnings and that would be a long term capital gain.  Is that correct?

[DanaB27 · Accepted solution]

1 and 2) If you leave the excess contribution in the Roth IRA then you will have to pay the 6% penalty tax. When you prepare the 2021 tax return TurboTax will asked if you had excess contributions in prior years then you will enter the amount and TurboTax will ask how much you want to apply to 2021.

3)It depends, if you met the 5 year rule then you will have a qualified distribution and this will not be taxable.

What Are Qualified Distributions?

A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.

1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
2. The payment or distribution is:

• Made on or after the date you reach age 59½,
• Made because you are disabled (defined earlier),
• Made to a beneficiary or to your estate after your death, or
• One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit). (IRS)

[Drfreud]

Thanks for that answer.  Two small clarifying questions.  If I remove the excess and the earnings on that excess prior to April 15, 2021, would I owe a 10% penalty on the earnings or only the normal tax rate for my income level?  If over a year since the investment, would that be considered a long-term capital gain or a short-term capital gain.

[macuser_22]

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@Drfreud wrote:

Thanks for that answer.  Two small clarifying questions.  If I remove the excess and the earnings on that excess prior to April 15, 2021, would I owe a 10% penalty on the earnings or only the normal tax rate for my income level?  If over a year since the investment, would that be considered a long-term capital gain or a short-term capital gain.

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Removing your own contribution is not taxable only the earnings are added to your income and subject to a 10% penalty on the earnings only.

If not removed by April 15 (or Oct 15 if you file on time or file and extension) then the earning stay in  the account but the excess contribution is subject to a 6% penalty that repeats each year until removed.

If you would rather pay the 6% on the excess and leave the earnings in the account then remove the excess as a regular distribution (not a "return of contribution") after Oct 15, but before Dec. 31.