Roth Overage

[rj1278]

Hello,

I' contributed to a Roth over 2020, but my income happened to exceed the allowable limit, so I'm receiving an overage notification within TurboTax stating I need to withdraw or be penalized year after year until corrected.  The entire amount of my contribution appears to be at play, so what is the recommended method to deal with the Roth moneys? 

I have a 401k and additional IRAs.  Roth appealed to us, because of it being liquid as well as the tax shelter for our future.  If converted to a regular IRA,  we would lose the benefit of having the contribution amount as liquid just in case we ever find ourselves in a pinch again, job loss, unknowns, etc.

I'm also uncertain what the ramifications may be if we transfer the Roth moneys to our Money Market account.  What will it mean with respects to out 2020 taxes and is there a recommended approach.

We're married filing jointly with only one income, should that assist in the answer.  Thank you in advance.

[DanaB27 · Accepted solution]

You can recharacterize your Roth contribution to a traditional IRA and make it nondeductible if your contribution to the Roth was limited because of your income. Then you will be able to convert it to a Roth IRA and the nondeductible part (basis) won't be taxable. This is called backdoor Roth IRA. Please see What Is a Backdoor Roth IRA? And How Does It Work? for additional information.

Another option is to withdraw the excess contribution and earnings by the due date, but then you would miss out on a contribution for 2020 if your contribution to the Roth IRA was limited by your income.

The total contributions you make each year to all of your traditional IRAs  and Roth IRAs can't be more than:

• $6,000 ($7,000 if you're age 50 or older), or
• If less, your taxable compensation for the year

If you decide to do this you will have to tell your bank that you want to recharacterize the Roth contributions as a traditional IRA contribution before the due date of the return (you will have to enter this on your 2020 tax return, please see below). There is no tax or penalty on the earnings since the earning will be simply switched into the recharacterized account. You will receive a 1099-R for the recharacterization.

Then later in 2021 you can convert the amount to a Roth IRA (this would be entered on your 2021 tax return).

You will enter the recharacterization when you enter the contribution to the Roth IRA (on your 2020 tax return):

1. Open your return 
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"

[Edited 1/21/2021 | 6:44am PST]

@rj1278 

[rj1278]

Thanks @DanaB27 ,

A couple of additional questions.  According to the article you posted, If I convert my Roth into a Traditional IRA, I can avoid the overage I'm faced now.  However, I read if I convert the traditional IRA back to a Roth I will have to pay taxes again?  Is that correct?  If so, that would suggest paying twice.  Would it make more sense to switch my work's 401k to a Roth instead of its current IRA?

Thanks.

[DanaB27]

Yes if you switch/recharacterize your Roth contribution to a traditional IRA  then you can avoid the excess contribution penalty (assuming that excess contribution is only due to MAGI and not because you had insufficient compensation to support an IRA contribution or were over the annual limit).

If you select to make the contribution nondeductible (step 9) then only the earnings will be taxable when you convert the traditional IRA to Roth IRA.

If you convert your 401k to the Roth than that will also be taxable unless you have a basis (after tax contributions) in your 401k.

[minimax]

Thank you for OP's question and Dana's answer! I have exactly the same issue. 

I have followed Dana's answer to recharacterize the Roth IRA contribution for 2020 to Traditional IRA. And I have followed the answer to enter info in the turbotax.

However, I have a follow up question: Can I do a backdoor Roth IRA immediately? If so, how to do it and how should I enter info in the turbotax? I saw other answers with how to file tax with backdoor Roth, but things got complicated with initial Roth Overage and recharacterization.

Thanks!!!

[minimax]

@DanaB27 thank you in advance!

[DanaB27]

Yes, you can do a backdoor Roth conversion right after you recharacterized you contribution. It sounds like the conversion will happen in 2021 then you will enter it on your 2021 tax return like this:

1. Login to your TurboTax Account 
2. Click on the Search box on the top and type “1099-R”
3. Click on “Jump to 1099-R”
4. Click "Continue" and enter the information from your 1099-R
5. 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”
6. On the "Your 1099-R Entries" screen click "continue"
7. Answer "yes" to "Any nondeductible Contributions to your IRA?" if you had any nondeductible contributions in prior years .
8. Answer the questions about the basis (you will enter the nondeductible contribution amount from 2020 and prior years, tracked on Form 8606).

[minimax]

Thank you @DanaB27 !!! This is so helpful!!! I will save your response and follow it next year when filling 2021 tax.

Wish you a good year and I wish to meet you on the forum again next year!

[mmihuc]

That was a great answer to the same problem I am having for 2020.  My wife's and my earnings were over the maximum amount .....  So, I have withdrawn the 2020 $7,000 contribution from my Roth account plus interest.  I now plan to deposit the $7,000 into my existing traditional IRA then pay taxes on the the interest portion.   Is that correct? 

[DawnC]

Yes, that is correct.  You will owe regular income tax on the earnings portion.   But you won't get the 1099-R until next year.   Enter the earnings portion on this year's tax return, however, so you do not have to amend it later.   Then, when you get the 1099-R next year, you won't need to file an amended return.  

You can enter the 1099-R that you will receive next year on this year's tax return, which will report the earnings income this year.  The IRA custodian won't send you the code JP 2021 Form 1099-R until near the end of January 2022.   You can enter it now to report this on your 2020 tax return as if you have already received Form 1099-R.  

• Box 1 = total received back
• Box 2a = earnings portion
• Box 7 = codes J and P

In the follow-up, indicate that this is a 2021 Form 1099-R.  On Form 1040, TurboTax will include the excess contributions on line 4a, the earnings on line 4b, and will include an early-distribution penalty (10%) on the earnings on Form 5329, if you are under 59.5.

The Code P drop-down will say ''earnings/excess deferrals taxable in 2019'' but it means taxable in the previous year which is appropriate in your situation since this is a 2021 Form you are entering.   Code P of a 2021 Form 1099-R will be taxable in 2020.   If you enter the form next year, it won't be taxable on your 2021 tax return, but you can ignore the message to amend your 2020 return as you will have already reported the earnings and penalty if applicable.     @mmihuc