I mistakenly contributed after-tax money to a traditional IRA in 2020. What now?

[KTM_Guy]

I contributed after-tax $7000 in November 2020 to a traditional IRA thinking that it would help reduce my taxable income when I filed my 2020 taxes.  After typing everything in Turbo Tax, w-2s, etc, I got a message that said, "...Modified Adjusted Gross Income (MAGI) is $141,000, which puts (name) over the limit for IRA deductions.  To deduct a contribution, you can't have a MAGI of over $124,000 while being covered by a retirement plan at work."

1)  Since I contributed after-tax dollars to the traditional IRA, can I just close the IRA (my first and only traditional IRA), get my $7000 back without penalty?   

2)  Or, if there will be a penalty (I'm age 50) for taking an entire distribution on the full $7000 I contributed (again with after tax dollars), then should I just recharacterize the traditional IRA as a Roth IRA?   And will I be penalized for that too?   

Thanks

[SamS1]

You must be covered by a retirement plan at work. Talk to your financial institution.  You should be able to re-characterize the Traditional IRA contribution as a Roth IRA contribution by doing a back-door Roth conversion in TurboTax.  Your financial institution will need to distribute out the money from your IRA and into a the Roth IRA.  Click here for more information.

[KTM_Guy]

Hello and thank you for the quick/helpful reply!  

Because I contributed after-tax dollars to the 2020 Traditional IRA, if I recharacterize that to a 2020 Roth IRA, and there wasn't really any gains/losses (it grew from $7000 to $7000.01 because it was just in a savings/money market), am I still going to either pay a penalty/or taxes?  (even though the original $7000 contribution was after tax dollars)

Thanks again!

[ThomasM125]

There shouldn't be any tax or penalty as long as you transfer the contribution to a ROTH IRA before the due date of your tax return and you don't earn any income on it before you do the transfer. Just tell your broker to transfer the contribution to a ROTH IRA.

[KTM_Guy]

Hello again,

And thank you for your time in replying to my question.  I contacted TD Ameritrade and explained to them what the situation was.  They provided a form for me to fill out "Roth Conversion Form."  But, I wonder if I should be filling out the "Roth Recharacterization Form."   I just hope whatever decision I make...Conversion vs. Recharacterization..there isn't going to be a penalty--because the contribution was made using after-tax dollars.  

I will also ask TD Ameritrade if they have any insight or IRA specialist who can direct me which form to fill out.  Roth Conversion or Roth Recharacterization.  My feeling is it doesn't matter since the after-tax contribution of $7000 is now only $7000.01.  There was no gain, or taxable gain, from the time the contribution was made.  

I'd appreciate any advice or suggestion on which form you think I should fill out--Conversion or Recharacterization?  Thanks and have a good weekend!

[AmyC]

You are doing a conversion. People will recharacterize a conversion. 

• Think of IRA conversions as allowing you to transfer funds from a non-Roth IRA account into a Roth IRA account, often with a taxable impact.
• Think of IRA recharacterizations as a set of special rules allowing you to change your mind about the type of your current year IRA contribution. As a result of the Tax Reform Act, beginning with 2018, recharacterization of a Roth conversion is not allowed.

See:

IRA FAQS - Recharacterization of IRA Contributions | Internal ...

IRA conversion vs characterization