I Overfunded My Roth IRA- Now What?

Reader Question: Concerning a Roth IRA. Suppose at the start of the year one is unsure how much their earnings would be due to overtime/bonuses.  What happens if I contribute the full amount allowed to a Roth IRA and end up exceeding the income limit that allows me to participate?  I want to maximize my saving but I don’t want any tax trouble! A.B.

Answer: First, for all of our readers, let me clarify your question. For 2014, you are allowed to contribute 100% of earnings up to $5,500 ($6,500 if you are age 50 or over during the calendar year). For joint filers, your eligibility to contribute to a Roth begins to get phased out if your modified adjusted gross income (MAGI) is $181,000 and is fully phased out with MAGI of $191,000…meaning if you earn more than $191,000 you are not eligible to contribute to a Roth IRA. For single filers the phase out is between $114,000 and $129,000. The IRS imposes a 6% excise tax on contributions plus the earnings on those contributions where you were not eligible. Here are four strategies you can use to address your issue:

  1. Elect to reverse the transaction. If it turns out you made ineligible contributions, you can have your broker ‘reverse’ the transaction and return your excess contributions plus the earnings on those excess contributions prior to filing your tax return for 2014 (including extensions) and all will be forgiven.
  2. Elect to convert your Roth to a non-deductible IRA. Since the contribution limits are the same for a Roth IRA and a traditional IRA, this could be an easy choice. Again, you’ll need to do this before you file your 2014 tax return.
  3. Wait until the end of 2014 or early 2015 to contribute to your Roth IRA. Obviously you lose a year’s worth of deferred earnings, but you do know exactly how much of a Roth IRA you qualify for.
  4. Use the secret strategy I use. My partner, Hugh Smith, CPA discovered a little-known loop-hole in the tax law that allows you to circumvent the income phase-out rules for Roth contributions. Here’s how it worked for me: First, I transferred 100% of my deductible IRA money into my company 401k plan (many plans will allow you to do this). Next, I made a maximum contribution to a non-deductible IRA because there are no income limitations for non-deductible IRA’s.   Finally, I immediately converted my non-deductible IRA to a Roth IRA and voila! By jumping through the hoops I was able to accomplish the goal of a maximum contribution to a Roth IRA even though I didn’t qualify for a direct Roth contribution because of income limitations. Now I do this in January of each year. The thing you must be careful about is if you have a traditional IRA and use this strategy, you must include the IRA in your calculations for the conversion and a portion of your conversion will be taxable as ordinary income. That’s why I rolled my IRA up into my 401k plan before implementing this strategy.

Reader question: I will be getting married to a wonderful woman later this year. I make about 40% more than her and I don’t expect a divorce; yet I want to keep my pension, 401k, other retirement accounts and house separate. I also want to keep her six figure student debt separate as she must pay a healthy payment monthly. I want to understand how to equitably pay for rent, bills etc. I want to be responsible for my rental where I lose about $400/ a month and she is responsible for her student debt of $1100 a month. I would like to understand how we both maintain separate retirement accounts. I would want to provide her access to these accounts upon my death and vice versa. Can you offer any advice?

Answer: It’s not sexy; it’s not romantic but there is a business element to marriage, particularly for couples who have already accumulated significant assets and/or liabilities. I would strongly encourage you to consider a prenuptial agreement that outlines some basic responsibilities related to debts and separation of assets. As to sharing expenses, there is no right or perfect answer but I like having a ‘shared’ joint account where you both contribute a portion of your paycheck for paying common bills such as utilities, insurance, entertainment, vacations, etc. You could each also have a personal account for paying personal bills and expenses. Typically I like to see equal amounts deposited in the personal accounts but you may want to make an ‘adjustment’ related to the debt you each brought to the marriage.

You will both need a last will & testament to direct where your assets go at your death. In addition, I strongly recommend a document for a power of attorney and living will. Be sure to change the beneficiary of retirement accounts and any life insurance to each other.

What’s most important is that you have open communications about your money and develop a plan together.