For "attributable earnings" for excess contributions to a (Roth) IRA, what exactly does "attributable earnings" mean?

[orangesherbet0]

I have a three-year-old Roth IRA with different assets. I accidentally over-contributed an excess of $4600 to my Roth IRA this year, because I only made $900 in wages the entire year (I'm a student living on financial aid).

I am instructed to "remove the excess contribution and any earnings attributable", but "attributable" can be interpreted very differently.

I purchased new assets with that $4600, assets that did not perform as well as assets already in my portfolio. If I say the (negative) earnings of *those* assets that I purchased with that money is "attributable", I will remove about $4400 dollars from my Roth. If I say the *entire Roth's earnings* is attributable, I will remove about $5000 from my Roth.

In other words, is the earnings of *those assets purchased with the excess contribution* "attributable"? Or am I supposed to pretend the contribution was evenly spread over *all* the assets in the portfolio.

What is the LEGALLY CORRECT interpretation of the rule?

[dmertz · Accepted solution]

The tax code provides the required calculation method and indicates that the earnings calculation must be done on the Roth IRA account as a whole.  The contribution is treated as spread across all assets in the account; you are not permitted to cherry-pick assets within the account on which to perform the calculation.  If your overall Roth IRA account balance gained about 8.7% between the time of the contribution and its return, your return of the $4,600 excess contribution will result in it being accompanied by about $400 of gains.  The IRA custodian is generally responsible for doing the calculation:

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

Note that you are permitted to obtain this return of contribution and avoid the penalty for 2017 only if by April 18, 2017 you either requested a filing extension or filed your tax return.  If you did not do one of these, the deadline for obtaining the return of contribution is not extended to October 15, 2018.

The gains are taxable and (because, presumably, you are under age 59½) subject to early-distribution penalty on your 2017 tax return.

[orangesherbet0]

This appears to include the case where the Roth experienced negative returns, i.e. the contribution "spread out over the whole" experienced losses, and hence the amount required to remove has also fallen.

Also, thank you very much for providing the link! Lots of advice about this question on the web, but nobody includes direct links to the actual laws. I can only give so many upvotes.

[dmertz]

Yes.  If the Roth IRA investments lost value in aggregate, the amount required to be distributed will be less than the amount of contribution returned.  But as Rainman12 indicated, there is no deduction for such a loss.

[orangesherbet0]

Oh...That seems bizarre. I thought the intention was to "undo" the mistaken contribution, by treating it identical to a non-IRA investment in a portfolio of securities matching the IRA. If you cannot deduct capital losses from a mistaken excess contribution, it seems to violate what I understand to be the intent of the law (it punishes). Can you cite anywhere it says this, or explain maybe why it is this way?

[orangesherbet0]

And just to clarify, I have to pay early-distribution penalty on this?! So in total, if you make an excess contribution and are under 59, you are guaranteed to either pay 10% penalty on gains, plus your individual tax rate on income, or no penalty on losses, but cannot deduct losses from income. Seems like these are punitive measures - designed to punish both those who experienced gains and losses. In my case, I experienced 30% gains on my excess contribution; it might make more sense to keep the excess contribution in my account.

[orangesherbet0]

I've decided that, for excess contributions that experience very high earnings during the first year, it does not make financial sense to remove the excess contribution. You're better off keeping the excess contribution, even if it takes a year or two of not contributing to get rid of the excess contribution.

[macuser_22]

If the excess is not removed by the due date of your tax return (or extended due date if a timely extension was filed) then the amount of excess is subject to a 6% penalty that repeats every year until the excess is removed (or can be applied to a future years contribution that would not be an excess).  In some cases of high earnings it pays to leave the excess in an pay the 6% penalty.

[dmertz]

The taxation of a return of contribution is described in CFR 1.408A-6 Q&A-1 (<a rel="nofollow" target="_blank" href="https://www.law.cornell.edu/cfr/text/26/1.408A-6">https://www.law.cornell.edu/cfr/text/26/1.408A-6</...>). A return of contribution is a distribution from the Roth IRA. The amount of the contribution returned is a nontaxable distribution of basis, but the gains are taxable on the tax return for the year in which the contribution was made. As a distribution from the Roth IRA, the gains are taxable in the manner that any taxable distribution from a Roth IRA is taxable. All taxable distributions are subject to an early-distribution penalty unless you have an exception that applies. Being the gains on a return of contribution is not an exception in the tax code.

I doubt that this was intended to be punitive, it's just a consequence of the way bits and pieces were added to the tax code over the years, perhaps an intended consequence that the lawmakers chose not to change.

Yes, if the gains are substantial, there are circumstances where it can be beneficial to pay the 6% excess contribution penalty one year then resolve the excess the next. I've done this myself. Correcting an excess contribution after the due date of your tax return and after having paid the 6% penalty for at least one year does not require the attributable earnings to be distributed. The excess can be resolved by either applying it as part of a subsequent year's Roth IRA contribution or by making a regular distribution. The regular distribution will not be taxable because it is a distribution of contribution basis (even though that basis may have come from an excess contribution).

[Rainman12]

You can'r deduct losses, so your earnings are zero.

[orangesherbet0]

That's not really what the question is asking

[Rainman12]

You have an excess contribution of $4600 which needs to be withdrawn, and there are no associated earnings.
Since you tracked specific performance, same as if you had separate Roth accounts.

[orangesherbet0]

See recommended answer

[Rainman12]

See also Worksheet 1-4 and surrounding examples at <a rel="nofollow" target="_blank" href="https://www.irs.gov/publications/p590a#en_US_2017_publink1000230879">https://www.irs.gov/publication...>

[orangesherbet0]

Ok, that covers what to do if there is a loss - you can't deduct the loss from your capital gains for that tax year. Did not know that, thank you. But it didn't answer whether the "earnings attributable to the excess contribution" are the earnings for the whole portfolio, or just the assets purchased with the excess contribution.