Oops, I Contributed Too Much in My Roth IRA
A few weeks ago, I received a letter from T. Rowe Price because I contributed $5,230 to my Roth IRA for 2008 – an excess contribution of $230. Bad, bad girl. But I’m not surprised. When I received an extra paycheck at the end of 2008 that wasn’t expected until early 2009, I knew there would be a problem because my Roth contributions are made via payroll allotment. To further complicate matters, I underestimated my earning potential for 2008. In other words: I am not eligible to contribute the entire $5,000. It hasn’t yet been determined exactly how much I can contribute, but to rectify the problem, I have one of four options:
Option 1:
Do nothing. Pay the IRS an annual 6% tax penalty on the excess until I fix the problem.
Option 2:
If the problem is resolved before the tax year deadline (Apr 15), I can request a distribution of the excess contribution (plus earnings), claim the earnings as income AND pay a 10% tax penalty on them as non-qualified distributions.
Option 3:
If the problem is resolved before the tax year deadline, I can request TRP redirect the excess contribution (plus earnings) from 2008 and put it in 2009.
Option 4:
Re-characterize the excess contribution as a Traditional IRA vs. Roth IRA.
I’m considering option #3 and #4, but leaning towards #4. I want to avoid this same drama next year because the thought of paying Uncle Sam a penalty, for any reason, gives me the heebeejeebies.
As a result of this annoying mistake, I will not contribute to my 2009 Roth IRA until April 2010. I will, however, continue to save the money in a savings account until I know if (and how much) I’m eligible to contribute for 2009.
I am not a tax professional. If you have inadvertently overpaid your Roth, please research the IRS website (Publication 590) or consult a tax professional for advice about the best solution for you.
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But I thought you can only put $5,000 total into your Roth plus your traditional, so #4 won’t work, right? It would work for the sliding scale part, but you’ll still have the $230 over.
I should clarify my statement. I will use a combination of 3 and 4 to address the 2008 issue: 3 for the overpayment and 4 for what I can not contribute based on income. In the future, I will contribute at the last minute or go with 4 all the way. However, I must admit, there is speculation of loopholes around the 5k, but I will not discuss them here. [-SM]
This is why I always did the Roths as lump sums. I’m sad to see it go, you will be too.
I would do the same – I’m not sure what your income is going to be in 2009, but I would fear a mess up again so I would probably go with #4.
Whatever you have to do to avoid the penalty!
Yeah, SM, avoid penalty, I would cease pay taxes all together if I had a choice – our money is used to bail out irresponsible CEOs that buy $6K shower curtains.
Very interesting problem to have…at least it’s a good one ;)
I agree w/ J,Money; what a good problem to have. I too would choose #4 to avoid the penalty. It’s crazy to have to pay a penalty for saving too much!!!
This happened to us last year when we were married. I finally convinced him to contribute $4k and then $3110 came back out. i’m waiting to see how we did this year.
I agree, avoid paying the fines/fees to the fed. It would give me the heebie jeebies as well (I’m so glad someone else uses that phrase!). If you can get some insurance that the same thing will not happen next year, you will be even better off. When I see how taxes are being used lately, it leads me to be less inclined to want to pay extra money to the government at all.
Jerry
If your investments would be in the market, it might be more profitable to invest some of that money early. What if you made regular contributions just for half the year, or contributed only half what you thought you might be able to do, and then topped it off in April?
I’d vote for #4 to maximize the total amount that is getting good tax treatment.
yep, #4. I personally find the whole ‘putting this year’s money in last year’s taxes’ massively confusing; I get that it’s an extra incentive but still what a nightmare keeping it all straight. I plan on doing this through April (I make contributions to the IRA every 15th of the month) especially since next year we will not be eligible for a Spousal Roth IRA (hi, that’s mine) just traditional nondeductible (for him) and deductible (partially) for me.
It’s all sort of messy, really, imo.
I had the same problem except for slightly more complicated. I tried to do the recharacterization but was informed by Fidelity we couldn’t. I also won’t have a drop in income next so putting it off till next year won’t help either. I took option 2 but fortunately had a loss. Didn’t have to claim additional income.
I got the check in the mail today. They took 40% for penalties. My question for Fidelity tomorrow is: why 40%?