Excess Roth IRA contribution with two brokerages

[afflax]

I made a contribution (less than $1,000) to my Roth IRA that I should not have in February 2017 with Fidelity. In March 2017 I moved the Roth IRA to Merrill. I received Form 5498 from Fidelity stating I had made a contribution. I have asked Merrill to move the contribution amount to a non-retirement account. Do I need Merrill to provide a specific form evidencing the move (they are in process of moving the amount)? Or do I need Fidelity to modify their Form 5498?

It appears I will not be charged a penalty, but would be good to hear confirmation on this.

Thank you!

[dmertz · Accepted solution]

The movement of the Roth IRA to a different custodian makes the process rather complicated.  A "return of contribution" before the due date of your tax return is required to be accompanied by any investment gain or loss attributable to the amount being returned.  The gain or loss is calculated over the entire account since the date the contribution being returned was made and that gain is then a proportional amount is allocated to the contribution being returned.

Because you moved the account, Merrill will not have the information needed to calculate the gain or loss, so they will rely on you to do the calculation according to CFR 1.408-11:

https://www.law.cornell.edu/cfr/text/26/1.408-11

Any gain required to be distributed with the returned contribution will be subject to ordinary income tax and, if you are under age 59½ and have no other exception, to a 10% early-distribution penalty.

A simpler alternative would be to leave the $1,000 in the Roth IRA for 2017, pay the 6%, $60 excess contribution penalty with your 2017 tax return, then after October 15, 2018 but before December 31, 2017 obtain a regular distribution of exactly $1,000 with no adjustment for gain or loss, eliminating the excess for 2018 and beyond.  This would even be the preferred approach if your Roth IRA account has seen significant gains since February 2017.  Avoiding the tax and penalty on the gains plus the future tax free growth on the gains are likely to more than make up for the $60 penalty you would have to pay for 2017.