Roth IRA Excess Contribution 2021 and 2022: Withdraw both?

[JamesPNW]

Hi all, I have a particularly unique situation with regards to my excess Roth IRA Contributions:

1. For Tax Year 2021, I contributed an excess of $1500 into my Roth IRA. I filed and paid the penalty. However, I did NOT withdraw the excess.

2. For Tax Year 2022 (not yet filed/submitted, in "review" and a draft, as of this writing), TurboTax reported that my modified adjusted gross income (MAGI) is over the Roth limit, which means that the entire $3200 contribution I made for 2022 is in excess. 

My question:

Do I withdraw both the $1500 I paid in excess in 2021 *and* the $3200? Or do I just withdraw the $3200?

An added complication/context is that I moved my Roth IRA from one institution to another in December. For some reason, I don't see any tax forms for the 2022 tax year from the former institution.  (I had contributed $300 in November and after moving my Roth IRA to a different institution, I contributed $2900 in December).

Towards the end of the Roth IRA section in filing for my federal return, TurboTax is saying I should withdraw the $3200, but it doesn't explicitly say to remove the previous year's $1500. (In an earlier, previous step - "[Enter] Your Excess Roth IRA contribution in previous years" - I entered the $1500 excess here - it has a footnote saying "Remember that excess contributions should be withdrawn to avoid additional tax"). Thank you in advance for any advice and expertise!

[MinhT1]

For the 2021 excess contribution to your Roth IRA, you need to withdraw the $1,500 if you want to avoid paying the 6% excise tax every year.  Remember that you will continue to pay that tax every year that the excess remains in your Roth IRA. As you did not withdraw it before 12/31/2022, you will have to pay the 6% for tax year 2022. 

For the 2022 excess contribution, you need to withdraw it (together with earnings/losses) before April 18, 2023 to avoid the 6% excise tax.

If you do this, on your 2022 tax return, you do not report the excess contribution as it has been withdrawn. The earnings have to reported and taxed in 2022. These earnings are also subject to 10% early withdrawal penalty if you are younger than 59 1/2.

If there is a loss, that loss is not deductible.

When you receive the 2023 form 1099-R (in 2024) for this withdrawal, there is no further action needed.

@JamesPNW  I have edited my answer after comments by dmertz

@dmertz  Thank you for your input.

[Edited 03/17/2023 | 12:48 PM PST]

[dmertz]

@MinhT1 is incorrect about the need to withdraw a gain/loss adjusted amount to correct the $1,500 excess contribution made for 2021.  The proper correction is to make a regular distribution of exactly $1,500.  Because the correction was not made in 2022, this $1,500 is subject to a 6% excess contribution penalty on your 2022 tax return, but the regular distribution of $1,500 in 2023 will eliminate this excess for 2023.

Also, if you file your 2022 tax return or request a filing extension by April 18, 2023, the deadline to obtain a return of the $3,200 contribution made for 2022 is October 15, 2023.  The distribution to accomplish a return of this $3,200 contribution will be adjusted for gain or loss on the $3,200 and MinhT1 described, with any gains being taxable on your 2022 tax return.  However, I believe that SECURE 2.0 eliminated that early-distribution penalty on gains distributed with a return of contribution, so in 2022 TurboTax you might have to claim an Other reason exception to the the early-distribution penalty on the gains if it appears.

[JamesPNW]

@dmertz thank you in advance as I ask for clarification.

The proper correction is to make a regular distribution of exactly $1,500

^ In other words, I should make a withdrawal from my Roth IRA of exactly $1,500, is that correct? Should I also withdraw the $3,200 in addition to the $1,500 (to avoid the potential penalty on the $3,200)? I’m reading “distribution” as “withdrawal”, but please let me know if that’s wrong.

Also, if you file your 2022 tax return or request a filing extension by April 18, 2023, the deadline to obtain a return of the $3,200 contribution made for 2022 is October 15, 2023.  The distribution to accomplish a return of this $3,200 contribution will be adjusted for gain or loss on the $3,200 and MinhT1 described, with any gains being taxable on your 2022 tax return.  However, I believe that SECURE 2.0 eliminated that early-distribution penalty on gains distributed with a return of contribution, so in 2022 TurboTax you might have to claim an Other reason exception to the the early-distribution penalty on the gains if it appears.

^ With about one month left, would you suggest an extension or have you seen financial institutions both execute a withdrawal and also provide the exact amount of gain or loss? For addl’ context, my taxes are just about ready to go - this is the only thing preventing me from moving forward. 

Thanks again for timely responses.

[dmertz · Accepted solution]

I generally don't use the word 'withdrawal' when talking about taking money out of retirement accounts.  The Tax code and the IRS use the word 'distribution' or the movement of funds out of a retirement account.  It's my belief that TurboTax's use of the word 'withdrawal' to make TurboTax feel more user friendly serves to confuse rather than help because the word 'withdrawal' to me implies unrestricted access to the funds.

You need to obtain two different distributions one regular distribution of $1,500 and one return of contribution of $3,200.  The Roth IRA custodian should calculate the gain or loss attributable to the $3,200 contribution being returned and will distribute the adjusted amount.  If the $3,200 contribution for 2022 was made in 2022, this gain will be taxable on your 2022 tax return, so you'll need to know the amount of the gain to be able to avoid amending your 2022 tax return to add the taxable gain when the code PJ 2023 Form 1099-R arrives next year.  If the $3,200 contribution for 2022 was made in 2023, it's likely that the Roth IRA custodian will report the return of contribution on a code-8J Form 1099-R and the gain will be includible on your 2023 tax return instead.

Note that instead of obtaining a return of the $3,200 excess contribution you could request that the Roth IRA custodian recharacterize that contribution to be a traditional IRA contribution instead, but the resulting traditional IRA contribution for 2022 might be nondeductible depending on whether or not you our your spouse was covered by a workplace retirement plan for 2022.