Probable Roth Overcontribution in 2021 - What to do?

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legalbeagle
Posts: 20
Joined: Fri May 10, 2013 8:08 pm

Probable Roth Overcontribution in 2021 - What to do?

Post by legalbeagle »

I wish to contribute the max to my Roth IRA for 2021. But I hover on the line where my income might push me into the $125k-$140k "phase out" category for Roth IRA contributions. While my base income leaves me entirely below the phase-out line, an end-of-year bonus is likely to push me over it (though likely still below the $140k cutoff).

Earlier this year, I did not think an end-of-year bonus would push me into the phase out category, as I was told by my new employer that I would become eligible to contribute to the company 401k plan in December, and I thus planned to contribute a large amount to the 401k in December. Factoring in that expected 401k contribution, I was fairly certain I would remain under the Roth IRA phase out line. So I went ahead and contributed the max to my Roth IRA for 2021.

Turns out my employer was wrong: I am not eligible to contribute to the 401k plan until January. That's somewhat of a bummer, but all in all it's not too big of a deal. But what I am fairly confident will happen now is that my 2021 income will end up falling somewhere in the phase-out category.

Other than the Roth IRA contribution mentioned above, I have not contributed any funds to any other retirement account for 2021. And I currently do not have any funds sitting in a traditional IRA either.

So my question is this: how do I go about fixing the likely over-contribution to my Roth IRA? I do want to contribute the max to my Roth IRA, so what would be the easiest way to accomplish that in this circumstance?
Last edited by legalbeagle on Sun Nov 28, 2021 11:11 am, edited 1 time in total.
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sarabayo
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by sarabayo »

When you say "my Roth", I assume you mean "my Roth IRA".

One solution is to make your 2021 contribution a backdoor Roth contribution.
  • Make sure you have no existing traditional IRAs (roll any into your 401(k) first if possible)
  • Recharacterize your contribution as a traditional contribution
  • Convert your traditional IRA balance (non-deductible) to Roth
Silk McCue
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by Silk McCue »

sarabayo wrote: Sat Nov 27, 2021 12:43 pm When you say "my Roth", I assume you mean "my Roth IRA".
What else would they mean if they are talking about contribution limits due to income? Their meaning is crystal clear.

Cheers
02nz
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by 02nz »

legalbeagle wrote: Sat Nov 27, 2021 12:34 pm I wish to contribute the max to my Roth for 2021. But I hover on the line where my income might push me into the $125k-$140k "phase out" category for Roth contributions. While my base income leaves me entirely below the phase-out line, an end-of-year bonus is likely to push me over it (though likely still below the $140k cutoff).

Earlier this year, I did not think an end-of-year bonus would push me into the phase out category, as I was told by my new employer that I would become eligible to contribute to the company 401k plan in December, and I thus planned to contribute a large amount to the 401k in December. Factoring in that expected 401k contribution, I was fairly certain I would remain under the Roth phase out line. So I went ahead and contributed the max to my Roth for 2021.

Turns out my employer was wrong: I am not eligible to contribute to the 401k plan until January. That's somewhat of a bummer, but all in all it's not too big of a deal. But what I am fairly confident will happen now is that my 2021 income will end up falling somewhere in the phase-out category.

So my question is this: how do I go about fixing the likely over-contribution to my Roth? I do want to contribute the max to my Roth, so what would be the easiest way to accomplish that in this circumstance?
When you get your W-2, you should see that the box for "retirement plan" is NOT checked, meaning you qualify to make a deductible tIRA contribution regardless of income. Assuming that's the case, I think the best course of action would be to recharacterize the contribution to a traditional IRA (I believe you have until the tax filing deadline to do so), and get the $6K tax deduction on your 2021 taxes.

The disadvantage there is that this leaves a tax-deferred tIRA balance, which will be a problem if you want to do the backdoor Roth in the future, unless your 401k permits incoming rollovers; I believe most plans do. An alternative is to recharacterize the contribution, also to tIRA, but make it nondeductible, so that you can then convert right away to Roth. However - I'm being careful here because of forum rules - the backdoor Roth may not be long for this world. And since you're a single filer and in a high-ish tax bracket, I'd rather take the tax deduction if I were in your shoes.
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sarabayo
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by sarabayo »

Silk McCue wrote: Sat Nov 27, 2021 12:52 pm
sarabayo wrote: Sat Nov 27, 2021 12:43 pm When you say "my Roth", I assume you mean "my Roth IRA".
What else would they mean if they are talking about contribution limits due to income? Their meaning is crystal clear.

Cheers
My comment was not intended to imply that I didn't understand OP's meaning. That is why I said I assumed they meant a Roth IRA. There are many Roth account types, such as Roth IRAs, Roth 401(k)s, Roth 403(b)s, and Roth TSPs. As you point out, only a Roth IRA has income-dependent contribution limits. But it's good to be precise, and not require the reader to deduce what kind of Roth account you're talking about from context.
tashnewbie
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by tashnewbie »

Did you make any 401k contributions in 2021 with your former employer?

If you did, then you can’t deduct a TIRA contribution. In that case, I would contact the IRA custodian and ask them to recharacterize the entire Roth IRA contribution. They’ll move that plus the associated earnings to a TIRA. Then you can convert that amount to Roth IRA (second step of the backdoor Roth). You’d owe ordinary income tax on the earnings. Only do the conversion if you don’t have any pretax balances in any non-Roth IRAs. If you do have such balances, move them into your current 401k (more than likely will take it).
Topic Author
legalbeagle
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by legalbeagle »

Thanks for the responses, everyone! Based on some of the questions, I went ahead and updated the original post with the following information:
  • I am indeed referring to my Roth IRA in the post.
  • I have not contributed any funds to any other retirement account for 2021 (I've had no access to do so).
One of the other responses raised something I had not really contemplated: simply re-characterizing the contribution as a Traditional IRA contribution and leaving it at that. Normally, I've been able to contribute to both my Roth IRA and company 401k, so I've never sorted out the potential advantages/disadvantages of choosing a Traditional IRA contribution or Roth IRA contribution in a year where a 401k or similar vehicle is unavailable to me. I realize that I haven't detailed my retirement savings setup to date. I don't mean to turn this into a portfolio review, but in general terms, my current setup is pretty simple: a Roth IRA and a 401k from former employer, and I use the three-fund approach.

I certainly would be interested in hearing (generally speaking) if there is a "better" approach with respect to contributing to a Traditional IRA v. Roth IRA in a given year for someone (1) in the $125k-$140k income range, (2) who has no access to a 401k or similar plan for 2021, and (3) does not currently have a Traditional IRA. (I will add that in January 2022, I plan to make the contribution to my company 401k plan that I intended to make in December 2021, but obviously that is a different tax year.)
AnEngineer
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by AnEngineer »

At your level of income, I'd probably favor a traditional IRA over Roth when available, unless you accumulate tax deferred balances sufficient to push you into a higher tax bracket when you retire. But that's a pretty fuzzy recommendation and depends on a bunch of stuff.

FYI, for future years, you can wait until your taxes are due for a year (April the next year) to make IRA contributions, so you can know your actual income before deciding.

You can also make backdoor Roth contributions even if not necessary if you know you want Roth but aren't sure on income. An existing traditional balance complicates this.
tashnewbie
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by tashnewbie »

As user above said, whether TIRA or Roth IRA would be better in your specific situation will depend on a number of variables. I don't think it's worth worrying over which will be optimal.

I would confirm with your current 401k administrator whether it will accept an incoming transfer of a pretax contributory TIRA (one that you've made contributions into and deducted on your taxes, not one that's a rollover from a prior employer plan). If it will accept such a transfer, for 2021, I would probably make and deduct the full $6k TIRA contribution (get your IRA custodian to recharacterize the past Roth IRA contribution you made).

Then in 2022, I would move the TIRA balance into your 401k (you would be out of the market likely for up to several weeks). Then I would proceed with normal backdoor Roths. I would assume my MAGI each year would make me ineligible to make full direct Roth IRA contributions, so I would proceed with the backdoor, instead of waiting until the following spring to calculate the exact MAGI.
newacct
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by newacct »

02nz wrote: Sat Nov 27, 2021 1:00 pm When you get your W-2, you should see that the box for "retirement plan" is NOT checked, meaning you qualify to make a deductible tIRA contribution regardless of income.
Only if their spouse was also not covered by a retirement plan at work in 2021.
tashnewbie
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Re: Probable Roth Overcontribution in 2021 - What to do?

Post by tashnewbie »

newacct wrote: Mon Nov 29, 2021 3:04 pm
02nz wrote: Sat Nov 27, 2021 1:00 pm When you get your W-2, you should see that the box for "retirement plan" is NOT checked, meaning you qualify to make a deductible tIRA contribution regardless of income.
Only if their spouse was also not covered by a retirement plan at work in 2021.
OP appears to file as single, not MFJ (or MFS), given that they referenced the phaseout range numbers for single filers.
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