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 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 weren’t supposed to make. First, you might have contributed too much. For 2023, your maximum contribution is $6,500 or $7,500 if you’ve reached the age of 50 this year. By the way, this contribution limit applies to the total of IRA contributions, whether you made them all to a Roth account, traditional IRA account, or a combination of each. Next year, the limits rise by $500 and will rise with the inflation rate, so be sure to adjust your contribution amount if you are trying to reach the yearly max. How could you contribute over the limit? Maybe you intended to contribute for 2022 before the tax filing deadline last April but had it attributed to 2023 and then made your normal 2023 contribution, so you had an erroneous double 2023 contribution. Or maybe you miscalculated the monthly amount and were overcontributing each month. We’ll get to the fix in a moment.

The second possibility is that you contributed when you weren’t eligible. Tax law has a threshold above which you can’t contribute directly to a Roth account. For a single filer, that amount for 2023 is $138,000 and $218,000 for married couples filing together. The good news is that the limit rises considerably next year and will each year with inflation. Maybe you had a banner year, an unexpected bonus, or a well-deserved promotion that boosted your income higher than you thought above those limits. Still, you had already made a lump sum contribution or had been making regular monthly Roth contributions. Or maybe you thought you would have enough earned income this year, but you stopped working completely or decided to cut back hours to where you didn’t make $7,500 this year (You can only contribute to an IRA up to the amount of earned income you have in a year or the limit, whichever is lower). In both situations, you over-contributed. As part of our wealth management and planning services, we take a detailed look at your income and contributions by performing withholding analysis and tax modeling so that we can advise you about your contribution options. 

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 “early withdrawal” as long as you undo it by the 2023 tax filing deadline in April 2024 or by October 15th if you needed to file 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 a New to Our Firm Intro Call today.