Roth IRA

Contributing Too Much To A Roth IRA

[As with anything tax-related, see my disclaimers.]

In 2013, I found out that I’d contributed too much to my Roth IRA during 2012. Our income had exceeded the income phase-out for Roth IRA contributions. It wasn’t until I was doing my taxes that I found out that I’d contributed too much during 2012.

Time to panic? Was the big bad IRS going to ding me with a penalty for not following the rules?

In short, no.

It was a very simple fix. I submitted a “contribution recharacterization” form with Vanguard, my IRA provider. The form asks them to retroactively switch a portion of my Roth contribution into a traditional contribution. Vanguard did all the math to divide any gains between the two contribution types, and then transferred everything into a traditional IRA account in my name. The only work I had to do was the form.

No IRS on my doorstep, no sweat.

Oops, I’m Doing It Again

Fast forward to 2020. We are again close to the income phase boundary and will likely not qualify for a full Roth IRA contribution for 2019. This time I’m aware of the issue and can avoid it.

Except I won’t. I’m going to make a maximum Roth IRA contribution, even though I suspect it’ll end up being too much.

Why, you ask, would I do this intentionally?

Timing Is Everything

The answer, in short, is timing the Federal Application for Student Aid, or FASFA.

This upcoming fall, Child #1 will be entering the halls of higher education. As I consider all of the options for funding her education, one of the key components is submitting a FASFA application.  This is required to qualify for, if any, financial aid. Every bit of money that I can stuff into retirement accounts or into our mortgage increases the amount of aid we can qualify for. So I’m making IRA contributions for both my wife and me, even though I don’t yet know how much of the contribution will qualify for Roth.

Rollover, Rollover, Send IRA Right Over

The recharacterized contribution won’t qualify for tax deductions because of the same income phase out. It’s money that I’ve already been taxed on. And because it’s a traditional IRA, when I withdraw the earning in the future, I’ll be paying tax again.

Where’s the fun in that?  I might as well put it in a brokerage account.

The solution is to immediately rollover the contribution into the Roth IRA following the recharacterization. There is no income phase out limits on the rollover. I’ll need to pay tax on any earnings between the time I made the contribution and the rollover, but chances are they’ll be pretty small or minimal. Might even be a loss that I can roll into future rollovers.

The catch to the rollover plan is that I can’t have any pre-tax traditional IRA money. The IRS expects me to prorate any rollover between the pre-tax and post-tax contributions. Luckily, I solved this years ago by rolling all of our pre-tax contributions into 401(k) plans where they are safe from the IRA rollover pro-rata rules.

So the process roughly looks like this:

  • Step 1: Contribute maximum amount of Roth IRA contributions [early January 2019]
  • Step 2: Complete the FASFA application [mid January 2019]
  • Step 3: Do our 2019 taxes, finding out how much we over contributed [early March 2019]
  • Step 4: Submit a “contribution recharacterization” with our Vanguard, if necessary [mid March 2019]
  • Step 5: Rollover any recharacterized contributions back into the Roth IRA, paying tax on earnings since Step 1 [April 2019]

Conclusion

Have you ever contributed more to your Roth IRA than you were supposed to? I’d love to hear about your experience.

Hasta luego!

2 thoughts on “Contributing Too Much To A Roth IRA

  1. After telling a colleague about the backdoor roth last year, he botched the implementation. Consequently he had to recharacterize then convert, paying a few dollars in taxes from interest earned along the way.

    My takeaway is that the backdoor roth dominates the regular roth. If you are anywhere near the roth ira phase out region, go backdoor to eliminate the risk of running afoul. There are no disadvantages.

    1. That’s a good point. I have the backdoor Roth all setup and have used it several times already. It would probably be easier to make a traditional IRA contribution and then roll it over instead of going the re-characterize route. Next year I’ll probably take that approach.

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