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Tutorial: Excess Roth IRA Contributions

 Excess Roth IRA contribution Defined

 An excess Roth IRA contribution is any regular contribution amount in excess of the lesser of the following amounts[1]:

o   100% of the Roth IRA owners taxable income/compensation for the year, or
o   $5,000 ( $6,000) for someone who is at least age 50 by the end of the year
Deadline for Removing Roth IRA Excess Contributions
Excess contributions must be removed from the Roth IRA by the Roth IRA owner’s tax filing deadline, including extensions. Individuals who file their tax return on time or file for an extension by the due date of their tax return, receive an automatic six-month extension. For individuals who file on a calendar year, the six-month extension ends on October 15. For instance, if the excess contribution occurred last year, the extension would end on October 15 of this year.
Transactions That Create Excess Contributions
There are several types of transactions that can create excess contributions in a Roth IRA. These include:
o   Making regular Roth IRA contributions in excess of the contribution limit in effect for the year, as noted above. In some cases individuals mistakenly make contributions to both their traditional IRAs and their Roth IRAs, with the total exceeding the limit in effect for the year. Where someone is eligible to make a contribution of $5,000, that amount can be split between a traditional IRA and a Roth IRA. However, the aggregate contribution to the two IRAs cannot exceed $5,000. If the contributions exceed $5,000, the excess is applied to the Roth IRA.
o   Rolling over amounts that are not rollover-eligible. If an amount is rolled over to a Roth IRA, and it is not an  eligible rollover distribution, it is treated as a Roth IRA contribution for IRS purposes. This can create an excess contribution in the Roth IRA, if the owner has already made Roth IRA contributions and/or the rollover amount is in excess of the Roth IRA contribution limits for the individual.
 
Example: John, a 75 year old individual, is required to take an RMD of $10,000 from his traditional IRA. Under the distribution rules, for any year that an individual is required to take an RMD from his IRA, the first distribution which occurs during that year includes the RMD amount. John was unaware that a Roth Conversion is treated as a distribution, and he instructed his IRA custodian to convert $20,000 from his traditional IRA to his Roth IRA.
As a result of this error, $10,000 of the $20,000 which was converted to John’s Roth IRA is his RMD for the year. This $10,000 is treated as a Roth IRA contribution, which is in excess of John’s contribution limit. John must remove the excess amount by his tax filing deadline, including extensions in order to avoid the 6% excise tax.
 
o   Making a Roth IRA conversion when one is ineligible to do so. For conversions that occur on December 31, 2009 and before, the Roth IRA owner must meet two requirements (1) her modified adjusted gross income (MAGI) must be $100,000 or less, and (2) her tax filing status must be anything but married-filing separately[2]. If an individual completes a Roth conversion when ineligible to do so, the conversion is treated as a distribution from the delivering account and a regular IRA contribution to the Roth IRA. Similar to the ineligible rollover contribution, this can create an excess contribution in the Roth IRA.
 
Completing a reconversion before the amount is eligible for reconversion.  If an amount is converted to a Roth IRA and subsequently recharacterized, that amount cannot be reconverted before the later of (a) January 1 of the year, following the year in which the conversion occurred and (b) 30-days after the recharacterization was completed. If the reconversion is completed earlier than eligible, the amount is treated as a regular distribution from the delivering account and a regular contribution to the Roth IRA. For more on this, see Tutorial: Roth IRA Reconversions
 
How to Correct a Roth IRA Excess Contribution
There are two primary ways to handle a Roth IRA excess contribution.
(1) Remove the Excess by the Deadline
Removing the excess contribution by the deadline is the only way to avoid the 6% excise tax. For an explanation of the deadline, see Deadline for Removing Roth IRA Excess Contributions earlier.
When the Roth IRA excess contribution is removed by the deadline, it must be accompanied by any net income attributable (NIA) to the excess. If the NIA does not accompany the return of the excess contribution, it is not considered ‘corrected’.
If the only credit to the Roth IRA is the excess contribution and the entire amount is being removed, the act of removing the entire balance is sufficient to correct the excess, as that would include the NIA.
If only a portion of the contribution is being removed, or if the account has balances attributed to other credits, such as Roth conversions, transfers, or other contributions, the IRS provided formula must be used to determine the NIA. The following is the formula used to compute the NIA:

NIA
=
Excess
[ adjusted closing balance
-
Adjusted opening balance]
 
Adjusted opening balance

           
Let’s look at an example to illustrate how the formula works.
John made an excess contribution of $10,000 to his Roth IRA on July 1, at which time his Roth IRA was worth $50,000. Since he had already contributed $6,000 to his Roth IRA for the year, the entire $10,000 is an excess Roth IRA contribution. He had previously made other contributions, conversions and transfers to the same Roth IRA. John submits a request to his Roth IRA custodian to remove the excess from his Roth IRA; at that time, the Roth IRA is valued at $65,000. No other activity occurred during the computation period [3].
The NIA is computed as follows:
 
NIA
=
Excess
X
-
 
 
NIA
=
$10,000
X
[ $65,000
-
$60,000]
 
 
$60,000
NIA
=
$10,000
X
[ $65,000
-
$60,000]
 
 
$60,000
NIA
=
$10,000
X
$5,000
 
 
$60,000
NIA
=
$10,000
X
-0.08
$833.33
 
Since the NIA is $888.33, the amount that must be removed from John’s Roth IRA to correct the excess contribution is $10,888.33 (excess + the NIA).
When NIA is a Loss
If the NIA had been a loss, John would reduce the $10,000 by the loss , and remove the net amount.
(2) Remove the Excess After the Deadline
If the excess is removed after the deadline and it is not accompanied by any NIA, John will owe the IRS a 6% excise tax for each year it remains in the Roth IRA as an excess.
Applying Excess to a Future Year
If the excess is not removed by the deadline, it is considered a contribution for the following year. However, unless John is eligible for a contribution for that year and the amount does not exceed his contribution limit, it creates an excess for that year. John will continue to pay the 6% excise tax, until the excess is used up for a future year, or removed from the Roth IRA.
Example:
Assume John’s excess contribution for this year is $5,000. If John does not remove it by October 15 of next year, he will owe the IRS a 6% penalty on the $5,000. The $5,000 will be treated as his Roth IRA contribution for next year; and unless he is eligible for that contribution (for next year); it creates an excess which is subject to the correction procedures explained above.


[1] These are 2009 figures
[2]These limitations are repealed effective January 1, 2010
[3] The period beginning immediately prior to the time that the contribution that is being returned was made to the IRA and ending immediately prior to the removal of the contribution.
 
                    I.            Tutorial: Roth IRA Contributions
                  II.            Tutorial: Excess Roth IRA Contributions
                III.            Tutorial: Roth IRA Conversions
               IV.            Tutorial: Roth IRA Reconversions
                 V.            Tutorial: Roth IRA Rollovers and Transfers

Great Information

This is the best explanation I have found so far.  Thanks for the great write-up. 

Thank you - appreciate the

Thank you - appreciate the feedback