Have you already contributed the max for 2007? (8k for you and wife)

How much earnings on the on the 8k did you make this year?

It seems pretty simple to me.

Back out the 8k (assuming max contribution), and pay the penalty and gains on the earnings.

Assuming 20% gain on 8k in 10 months (worst case having funding all 8k in JAN) that is $1600.

Pay capital gains and penalty on $1600, were not talking a huge loss here.

quaters said:Have you already contributed the max for 2007? (8k for you and wife)

How much earnings on the on the 8k did you make this year?

It seems pretty simple to me.

Back out the 8k (assuming max contribution), and pay the penalty and gains on the earnings.

Assuming 20% gain on 8k in 10 months (worst case having funding all 8k in JAN) that is $1600.

Pay capital gains and penalty on $1600, were not talking a huge loss here.

We'll probably go this route, if option #3 can't be done. However, contributions were spaced out every month, $333/each. A pain in the butt to calculate earnings with the intermittent contributions, and the IRS doesn't seem to have to any forms to do this, so who knows if they'll "accept" my calculations.

taxmantoo said:tonygDES said:Just looked up IRS publication 590, and if you're married filing jointly AND you have a retirement plan at work (which I do), then you can't deduct traditional IRA contributions if you make more than $85,000.

And therefore you acquire a basis in your traditional IRA. If you keep track of the account's basis, then you will only be taxed on the income, not the return of basis when you w/d from the account. In real life, nobody ever knows what their basis is, and they end up paying tax on the entire w/d. If you stick with one firm for your tax prep for the rest of your life, they should keep track of your basis in nondeductible IRAs for you.

Not to mention, in 2010, you can convert the Traditional IRA to a Roth IRA and only pay taxes on the earnings between now and then since the non-deducted contributions would form a basis not subject to tax.

Also, have you called the company that opened the Roth IRA? They may be fix it in the same year with no penalty.

tonygDES said:First post in Fat Wallet Finance... long time lurker, but hopefully I can find someone that has been through this situation and hopefully this thread can educate others.

A month ago, I received a $15k bonus from work which will make my wife & I completely ineligible to fund a Roth IRA for 2007 (>$166,000 AGI).

I've researched what the options are and here goes my questions/comments for each option:

1) Get hit with a 6% excise tax on 2007 Roth IRA contributions - more taxes, BOO! Not willing to do this.

2) Withdraw all Roth IRA contributions AND EARNINGS for 2007 - it seems you can withdraw the contributions without penalty, but I think the earnings will be taxed both for capital gains and for the 10% early withdrawal penalty. Does anyone have any insight on this?
Roth IRAs do not generate capital gains. The earnings will be taxed as ordinary income plus the extra 10% tax if you are under 59 1/2.


3) Reclassify 2007 Roth IRA contributions as 2008 Roth IRA contributions - this is the most appealing option for us, as DW won't be working full time in 2008. However, the IRS website does not go into detail how to do this, or what should happen to any earnings made in 2007. Has anyone successfully done this?
You will still have to pay the 6% excess contribution tax on the contribution, but you will not have to pay any tax or penalty on the earnings and you can leave the earnings in the Roth IRA account. The overcontribution penalty is calculated on Form 5329. When you fill out your 2008 Form 5329, on line 18 you will put the overcontribution from 2007 and on line 19 you will put the amount of the contribution you could have made for 2008, but didn't. Line 19 becomes part of the total on line 21, which is then subtracted from line 18 to arrive at your overcontribution for 2008. This would be a good option if your earnings for 2007 were more than 6% of your contribution, since it allows you to leave the earnings in your account.

4) Reclassify 2007 Roth IRA contributions as 2007 Traditional IRA contributions - I've found this is an option as well, but I don't like this as I will essentially be taxed twice on the contribution (once now, and again when I pull the funds during retirement). This seems worse than option #1, if my post-retirement taxes are >6% (most likely)
This is called "recharacterization.".
I have no idea why you say you will be taxed twice.
You will need to recharacterize both the contribution and the earnings into a traditional IRA. There is no tax on the recharacterized amount. If you are eligible to take a deduction for a traditional IRA contribution, then you may deduct the recharacterized contribtion (but not the earnings). If you are not eligible to take a deduction, then you fill out Form 8606 to indicate that you are not deducting the contribution and then you may exclude the non-deductible amount from taxes when you take distributions. In neither case will you be taxed twice.

And, remember, that you will be able to convert the traditional IRA to a Roth IRA. Since you say your income will be lower in 2008, you may even be eligible to do it in 2008. Certainly you will be able to do it in 2010 (if the law doesn't change). When you convert, the part of the conversion that comes from non-deductible traditional IRA contributions does not get taxed.

Unlike option 3, this option will let you make another Roth IRA contribution in 2008. Then when you convert your traditional IRA, you will have both 2007 and 2008 contributions in your Roth IRA. Under option 3, you would skip your 2008 contribution.

frootmall has it right...

At this point, your best bet is to recharacterize the 2007 contributions as a Traditional IRA, even if ineligible for a deduction. In 2010, you (hopefully) will be able to rollover the Traditional IRA to a Roth IRA if you want, and only pay the taxes (for the rollover) on the gains (2010 value - $8k basis/original contribution). Then it should be a tax-free Roth until you start withdrawing. This all depends on Congress not changing the tax code between now and then, but I'd say that's unlikely (probably less than 1:5 chance). Regardless, you may still be able to rollover the Traditional IRA to a Roth IRA before then if your salary drops below the limits.

Thanks everyone, the information here has been very helpful!

The reason I say I will be taxed twice is because I have made Roth IRA contributions using after-tax money (first round of taxation), then if those contributions go into a traditional IRA, then would be taxed again when withdrawals are made (second round of taxation). But, as frootmall points out, it looks like I can deduct those traditional IRA contributions when I take withdrawals during retirement since I was not able to deduct the contributions from my AGI today. Do I have it right?

OP - read the tax pubs and don't depend on other's interpretation. IF you remove the excess contributions before you file your taxes next year, you do NOT have to pay the 6% penalty.

tonygDES said:Thanks everyone, the information here has been very helpful!

The reason I say I will be taxed twice is because I have made Roth IRA contributions using after-tax money (first round of taxation), then if those contributions go into a traditional IRA, then would be taxed again when withdrawals are made (second round of taxation). But, as frootmall points out, it looks like I can deduct those traditional IRA contributions when I take withdrawals during retirement since I was not able to deduct the contributions from my AGI today. Do I have it right?

Yes, you have it right. Be sure to file Form 8606 and hang onto it so you have proof that you already paid tax on that money.

But, assuming you don't have a traditional IRA with a lot of before-tax money in it already, you would probably be better off planning to convert that traditional IRA into a Roth IRA the first chance you got. The after-tax money (i.e., non-deductible contributions) that you convert would not be taxable and it would grow tax-free in a Roth instead of tax-deferred in a traditional IRA.

If you already have a traditional IRA with a lot of before-tax money in it, that becomes a bit more of a problem, since any conversion or distribution will be considered to be partly before-tax money and partly after-tax money. But it sounds like you don't have a traditional IRA at this point, so you won't have to worry about that.

frootmall said:

But, assuming you don't have a traditional IRA with a lot of before-tax money in it already, you would probably be better off planning to convert that traditional IRA into a Roth IRA the first chance you got. The after-tax money (i.e., non-deductible contributions) that you convert would not be taxable and it would grow tax-free in a Roth instead of tax-deferred in a traditional IRA.

If you already have a traditional IRA with a lot of before-tax money in it, that becomes a bit more of a problem, since any conversion or distribution will be considered to be partly before-tax money and partly after-tax money. But it sounds like you don't have a traditional IRA at this point, so you won't have to worry about that.

Bleh, I already DO have a traditional IRA with a sizeable amount in it from a previous rollover when switching companies. Maybe I could park the transferred money in a different mutual fund until I switch it to a Roth to 'earmark' the transferred money easier. The wife doesn't have a traditional IRA yet, so it will be no problem for her.

Just paying the 6% excise tax is looking so much easier now... only $200 penalty per account for this year ($3330 contributed per Roth account). It would put a good dent in the 14% returns I made so far this year in the Roth accounts, but far less headaches.

Thanks for the help all. Much appreciated.