Should I just close my Roth IRA?

[vitaminDD]

I'll try to keep it short.

• Put too much in Roth IRA 2020, took it out Feb 2021. Filed my taxes. 
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• There is $150 in earnings that will need to amended in my 2020 when I get the 1099-R spring 22'.
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• Therefore the $150 will increase my MAGI making my initial withdrawal not enough to cover this hole. 
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• Basically I'd have to pay a 6% penalty on maybe like $20, etc.

Because this is a just opened Roth IRA with only a few thousand in. Doesn't it make more sense to just close out the entire account before April 15 and just pay the penalty on the earned income just one time on the amended return and not have to deal with the 6% penalty on the overage cause by the increase of MAGI by $150. 

[DanaB27]

If you close your Roth account then please be aware you can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free.  But the earnings will be included in your taxable income  and you will have to pay a 10% early withdrawal penalty if you are under 59½.

You could also recharacterize the excess contribution as a traditional IRA and make it nondeductible to be able to convert it to the Roth IRA later. This way you avoid the 6% penalty. Also, there is no tax or penalty on the earnings since the earning will be simply switched into the recharacterized account. 

If you want to do this then you will have to make this request with your bank to recharacterize  your Roth contribution as a traditional IRA contribution.

If you choose to recharacterize the Roth contribution as a traditional IRA contribution then follow these steps to enter this on your amended 2020 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 “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"

[vitaminDD]

Turbo Tax said my excess was $2000 when I filed last month and I already removed the excess + earnings and submitted my return. 

My question is would it be okay just to close the account instead of dealing with the MAGI going up and that calculated excess removed not being enough. I rather pay the 10% penalty on the measly few hundred earnings than have to amend another tax return to show I removed the excess caused by another excess on the same tax year. 

[DanaB27]

Yes, if you prefer to close the account then you can do this and will get a 1099-R 2021 for your distribution that you will include on your 2021 return. After you entered your 1099-R please make sure you answer all follow up questions in regards to the Roth IRA, so only the contribution amounts will be excluded from taxable income.

Please be aware you still get the 1099-R 2021 for the withdrawal of excess contribution and earnings which will have to be entered on your 2020 amended return (unless you reported it already on your original 2020 return by creating a 1099-R).

[vitaminDD]

Thanks Dana for all this insight.

So the $2000 I removed I will be getting a 1099-R in Spring 22' to Amend for the 2020 Tax Return.

If I close the Roth IRA today before April 15th deadline it would count towards 2021's return not 2020? 

Would these two things show up together when I get my 1099 in the Spring 22'?

But to be clear once I close the account this week, my extra earnings from the original excess removal bumping up my MAGI would in essence no longer be a problem because the Roth IRA doesn't exist anymore? 

[DanaB27]

Yes, the $2,000 withdrawal of excess contribution plus earnings will be on your 2020 tax return (amended) and you get a 1099-R 2021 in 2022 with codes P and J.

To avoid the 6% penalty you will have request another withdrawal of excess contribution plus earnings to eliminate any excess contribution on your 2020 tax return when you close your account before the due date.

Then you will have to include the earnings on your 2020 return but if you remove the whole contribution and earnings because you are closing the account then this will eliminated the 2020 Roth contribution completely and you will not have any issues.

[vitaminDD]

So just to be clear. I already removed the excess amount with the earnings from 2020 and filed for 2020.

My main goal is to prevent when I get that 1099-R to amend the 2020 return... the earnings will bump up my MAGI and make the original withdrawal insufficient because my allowance would even be less with the slight increase in income sending me into this excess withdrawal loop. 

My goal is to just close the Roth IRA account completely. It was started in 2020 and only had $6000 original input. I took out the $2000 plus earnings. I want to close out the account and transfer the remaining amount to a brokerage account so hopefully when I amend my 2020 return I'd just be paying the 10% penalty and not be worrying about removing even more from the account because of the increased MAGI.

@DanaB27 

You wrote:

To avoid the 6% penalty you will have request another withdrawal of excess contribution plus earnings to eliminate any excess contribution on your 2020 tax return when you close your account before the due date.

... I'm confused by this. Why would I need to request another withdrawal of excess but I'm going to close the entire Roth IRA account and remove every single dollar in it. Technically I should be just on the hook for the 10% on the earnings correct? 

Like when I amend my 2020 return next year they are going to see the earnings and tax those as income + 10% but it won't be like oh well your Roth IRA is over and more needs to be removed because I technically closed the account and there are no more contributions. 

[DanaB27]

Yes, I understand that you already withdrew an excess contribution and that the taxable earnings caused an increase of MAGI which triggered another excess contribution.

You will close your account with the request to withdraw the whole $4,000 as excess contribution plus earnings so the bank will code the 1099-R correctly to avoid having to pay the 6% penalty.

Then you will just amend your 2020 tax return when you get the 1099-R in 2022, pay the 10% penalty tax on the earnings and enter that you withdrew the whole contribution on the “You have a penalty” screen. Then you will be done with it for the future.