Taking a Mulligan on a Roth Contribution

IRAs, 401ks, Roth, Traditional, tax brackets, MAGI (are those the same guys as in the Bible?), contribution limits; there’s a lot to know regarding retirement contributions and what you can do when. We’ve typically advocated that you get a good portion of your money into a Roth-sheltered account because the growth is tax-free, and the withdrawals are tax-free after age 59 ½. Maybe after coming to work with us, we discovered together a gaffe with your contributions, or maybe you’re reading this, completed a Roth contribution at some point this year, and what I’m about to share will make you go “Oops, I did it again” (That song was referenced on the Weather Channel just a few minutes ago while I’m sitting in a North Platte, NE hotel eating breakfast, so I couldn’t help myself from being quirky).

Why would I need to fix a Roth IRA Contribution?

You have two likely reasons to fix a Roth contribution you were not supposed to make. First, you may have contributed too much. Contribution limits for IRAs change over time, and the annual cap applies to the total of your Roth and traditional IRA contributions combined. It is easy to accidentally go over. Maybe you miscalculated your monthly amount, doubled up for the same tax year, or did not realize the limit had adjusted.

The second possibility is that you contributed when you were not eligible. Roth IRAs have income thresholds that restrict who can contribute directly, and those limits change annually with inflation. A big bonus, job change, or reduction in earned income could all shift your eligibility after you have already made contributions.

In both situations, the result is an over-contribution. As part of our wealth management and planning services, we review your income and retirement contributions in detail using withholding analysis and tax modeling so we can advise you on the best course of action.

What are the steps to fix a Roth IRA contribution?

If you’ve encountered any of these contribution snafus, you have a few options. First, you can remove contributions by completing an excess contribution form, which is unique to each brokerage account or custodian. Thankfully, the SECURE 2.0 Act removed penalties for making this type of early withdrawal as long as you reverse it by the tax filing deadline for that year or by the extended filing date if you request an extension. Any earnings from the mistaken contribution will be reported as income in the same way as a taxable investment account. The timing and process can get complicated, so schedule a time with us or contact the tax pro you normally use to file your return.

A second option is to recharacterize your contribution, which means you change the “character” of your contribution from one type to the other. For example, because of that banner year, you are ineligible for a direct Roth contribution, but you are always eligible for a traditional after-tax IRA contribution because there are no income limits for those (the income limits only apply to whether that contribution is tax-deductible). That potentially leaves the door open for a “backdoor” Roth contribution. You will report this recharacterization on your tax return when you file, so be sure to let your tax preparer know if you executed a recharacterization in 2023.

Report & Watch for Excess Contributions

You or your tax preparer will use Form 5329 when reporting any excess contributions and any penalty that might be due (that penalty is only if you fail to fix it in time). If you fail to fix your excess contributions, you pay 6% per year for every year that passes, and you continue to miss correcting the error. Visit the IRS for more information on tax penalties for IRAs. 

We are always on the lookout for situations like this for clients, especially for clients who are new to The Dala Group, because we are just starting to familiarize ourselves with your situation. This is why we regularly request you send us your tax return so we can get a full picture of your finances and catch anything that may have been missed. Clients have realized significant refunds and savings through our tax review service, so take advantage of this when we request your return in preparation for your annual review meeting. With The Dala Group, you always have a partner looking out for your best interests. Keeping your contributions and taxes on the radar is only one of the many ways we do that. If you’re interested in exploring what it looks like to have us by your side, schedule an  Intro Call today.