Withdrawals of contributions by due date.

[mgc6288]

During the 2023 tax year I contributed $3500 both to my Self Employment Individual Roth 401k and my wife's Individual IRA.  For the last 8 weeks business has plummeted from last year's 5 clients/day to 2 clients/week and my wife and I have agreed to withdrawal this current 2023 tax year's contributions of $3500 mine + $3500 hers which should avoid the 10% penalty.  This will give us a cushion of a few months while I figure out what I can do in order to provide.

I read IRS Pub 590b where on page 31 it states, "Withdrawals of contributions by due date. If you withdraw contributions (including any net earnings on the contributions) by the due date of your return for the year in which you made the contribution, the contributions are treated as if you never made them. If you have an extension of time to file your return, you can withdraw the contributions and earnings by the extended due date. The withdrawal of contributions is tax free, but you must include the earnings on the contributions in income for the year in which you made the contributions."

I'm ready but I have not filed my 2023 1040 yet and this wording suggests that if I do withdrawal this then I need to add the earnings to my income for 2023 before filing.  

Is there a 10% penalty on withdrawn contributions during by the due date?  

Do earnings have to be pulled out?  I hear they may be subject to a 10% penalty.

How is this process even initiated with Vanguard?  They only point me to an excess withdraw form but none of the four options appear to fit:

Nondeductible contribution: Employer contributions to a qualified plan in excess of the applicable deduction limit for the plan year.

Excess deferral: Employee deferral in excess of the limit under the Internal Revenue Code (IRC) Section 402(g).

Excess annual additions: Total additions to a participant’s account, which exceed the lesser of 100% of the participant’s compensation or the dollar limits under 415©. These may include both salary deferral contributions and employer contributions.

Mistake of fact: A mistaken contribution (generally due to a mathematical error). The types of errors that may be considered a mistake of fact are very limited (see IRS Revenue Ruling 91-4).

None of these sound like this situation as neither account was contributed to over the $6500 limit.  Thank you.

[fanfare]

You take it back by requesting a -- return of excess contribution:

before tax filing date including extension: positive earnings allocable to the excess are included in income on 1040 Line 4b for the year of the contribution. negative earnings are ignored; in any case, for purposes of basis, consider the original requested amount as returned.
For a Roth IRA, the taxable amount is found on Form 8606 Line 25c.

You must have a) filed by tax day, or b) requested an extension of time to file by tax day to take advantage of the Oct 15 deadline.

positive earnings removed are no longer penalized 10% if you are under age 59 1/2. (eliminated in 2023)

@mgc6288 

[fanfare]

"Self Employment Individual Roth 401k"

There may be some nuances for this type of account.

I'm not familiar with it.

@mgc6288 

@dmertz 

[mgc6288]

Wow, thank you for the quick response! 

Do I use 8606 for both my Roth 401k withdrawal as well as my wife's Roth IRA withdrawal?  Reading the instructions does not mention 401k but only IRAs.

If this is in fact an excess withdraw, then is a same year withdraw considered a Nondeductible contribution, Excess deferral, Excess annual additions, or Mistake of fact as Vanguard defines above?

[fanfare]

It was quick because I didn't study your Vanguard part which is apparently where your account is and they have questions about it.

You can just say "non-deductible excess", which is the same you would say for a Traditional IRA, except the question is not asked (custodian doesn't care)

@mgc6288 

[fanfare]

On second thought it sounds like "excess annual additions".

@mgc6288 

[dmertz · Accepted solution]

The Vanguard form that you describe appears to be for removing excess contributions made to the 401(k), not for a return of contribution from an IRA.  You probably need a different form for the IRA.

If your Roth 401(k) employee contributions are not excess contributions, you are not permitted to take them out until age 59½ or becoming disabled, except as a hardship distribution.  A hardship distribution from the Roth 401(k) will be a proportionate mix of your contributions (nontaxable) and gains (taxable and subject to a 10% early-distribution penalty).  This would not be a return of contribution, so there is no attributable net income calculation the way there would be with a return of contribution from the IRA.

With regard to a return of contribution from the IRA, the SECURE 2.0 Act eliminated the 10% early-distribution penalty on the taxable attributable net income.

Form 8606 is not involved with either of these types of distributions.

[mgc6288]

Hmm...confusion.  So even though I am attempting to backtrack this year's $3500 Roth 401k contribution, once it is in there, then there isn't any way of pulling it out without a 10% penalty?  Not even the same year?  

The Vanguard IRA process is convoluted at best, but you're saying do not use form 8606?  

[dmertz]

If the Roth 401(k) contribution is not an excess contribution, you are not permitted to undo the contribution the way you can for IRA contributions.

[fanfare]

I said:

For a Roth IRA, the taxable amount is found on Form 8606 Line 25c.

you said:

Form 8606 is not involved with either of these types of distributions.

Are you saying my statement is incorrect ?

@dmertz 

[fanfare]

@dmertz 

My statement is right.

your statement confused me.

[mgc6288]

Well this whole process confuses me.  I've had a solid business for 20 years and then literally, this year for 8 weeks now business has tanked from 25 clients a week to 2 clients.  I've been in touch with my core clients and they're happy.  Some of cut back to due their customers cutting back but no one is upset or disappointed in any mass way.  This is entirely a shocking experience and this month is looking to turn out no better so realizing that saving will only go so far and the word "recession" floating around.  My wife and I decided to hold cut our expenses and pull our funds that we can from the IRA now if a 10% doesn't apply.

The Roth IRA sounds like it is possible but just a matter of the proper format.  Vanguard doesn't make this process easy at all.  

The Roth 401k I thought was also able to avoid the 10% penalty as in 2017 I asked Vanguard if I could withdraw from the max that I had contributed and they suggested I could since it wasn't 4/15/18.  I didn't but at the time I thought I might have had to for a different investment opportunity.  I scratch my head on the Roth 401k not allowing as that means once submitted then there isn't any pull out.  I could understand for a Traditional 401k as there is tax deductions involved at the employee and employer level but the Roth 401k?!?  There isn't any employer matching as I'm self-employed.  More investigation is needed.

[dmertz]

@fanfare , I saw no mention of a Roth IRA being involved.  My understanding is that the two accounts involved are a Roth 401(k) and a traditional IRA.

[mgc6288]

You're right.  My first post just stated my wife's IRA whereas my second post lists Roth IRA.  Does your suggestion change on the 8606 with it being a Roth IRA?

[dmertz]

A return of contribution does not go on Form 8606.  If she instead takes a regular distribution from the Roth IRA and it is not a qualified distribution, the distribution must be reported on Form 8606 Part III.