Roth IRA Over-contribution, can't disburse full initial amount

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DRReaders
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Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

I have a Roth IRA that I opened in 2021 and contributed the full $6,000 amount to (for 2021 and 2022). I originally anticipated being way lower than the Roth IRA income threshold, but due to several events, my income for 2022 will likely be well over that amount. The account currently has less than the amount I put in at around $5,000.

Given the situation above, what options would I have to resolve the issue.
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Edit: I've been in touch with an accountant that's worked for the IRS for 10+ years in the past and the brokerage that holds the Roth IRA account.

The brokerage representative offered this advice which seems incorrect, "Because your overcontribution accounts for half of the total contribution for the account, removing half the current account value (in this case $5,000) would be sufficient." He did specify that he was just speculating and this was just what he thought should happen. It doesn't seem like the brokerage would be able to provide a value of how much I should withdraw to compensate for the $6,000 contribution at the beginning of 2022.

The accountant said, "It was very stupid to contribute before the end of the year before you knew what your taxable income would be and how much you could contribute to the Roth IRA (I agree with him that I should have planned for this better). At the point, no one knows how much your $6,000 contribution has become with gains/losses. You will be penalized by the IRS for the overcontribution because no one knows how much you should be withdrawing."

At this point I'm not too sure what advice that was given is valid and if I have any options to resolve this issue.
Last edited by DRReaders on Sat May 21, 2022 7:24 pm, edited 1 time in total.
secondcor521
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by secondcor521 »

1. If you want, you can remove the original contribution plus or minus attributable earnings. With the facts you cited, you can just remove the entire account balance even though it's less than your contribution and be fine. If you choose this option, just call your Roth IRA custodian and tell them you want to withdraw the $6K excess contribution, and they should do the proper thing for you.

2. Even though you are above the Roth contribution AGI limit, you should be eligible to do a backdoor Roth. This would entail recharacterizing the Roth contribution (plus or minus attributable earnings, so again, whatever the balance is in your Roth currently) to a non-deductible traditional IRA contribution, then converting that back to a Roth IRA. You'd have to do the recharacterization before 10/15/2022 (tax filing deadline with extensions). You'd report the Roth conversion on Part II of Form 8606 in the tax year in which you did the conversion (probably 2022).
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retiredjg
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by retiredjg »

Be careful about assuming the current value unless that is the only thing in the account. I think we have heard that the custodian uses the value of the whole account, not the value of the specific investment, to determine what the "associated earnings" for a contribution are.

If there are no other traditional IRA's in the way, you can have the custodian re-characterize that contribution and earnings (or losses) to tIRA and then do a Roth conversion. This would be the "backdoor Roth" process.

If you have other IRAs that can't be moved or just don't want to get involved with the backdoor method, have them return the contribution and earnings (or losses) to you as if the contribution never happened. Earnings will be added to your 2021 taxable income.
tashnewbie
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by tashnewbie »

I would start by confirming you weren’t eligible to contribute the full amount to Roth IRA. See this IRA link for the MAGI limits: link. At this point you can fill out a draft tax return and accurately calculate your MAGI (likely will be the same as your AGI but it’s not for everyone).

If you really are ineligible to contribute the full amount, then as others above described, re-characterization followed by a Roth conversion is probably the easiest way to handle this that allows you to keep the money in the Roth IRA. Only do that if you don’t have any non-Roth IRA. Otherwise, you can ask IRA custodian to return excess contribution.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

Thanks all for the advice, I'll look into both the options to remove the rest of the balance and backdoor Roth conversions.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

I'm bumping this post because I've edited it with new information and advice that I've received from an accountant and the brokerage holding the Roth IRA. Trying to seek some more advice here if anyone is familiar with any options I have. Thanks in advance.
shess
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by shess »

The year I retired, I topped off my backdoor Roth IRA contribution, and then early the next year when reviewing my taxes, I thought "I should just get this done early rather than waiting until the last minute again", and did it again ... in a year with no earned income. Later I realized what I had done. When I unrolled it, Vanguard simply figured it out and cut me a check, and later cut me a 1099-R. There was no weird estimation or anything on my part. The previous value of my Roth IRA didn't seem to be relevant in any way.

IMHO, if you have $0 in traditional IRA assets, your best bet would be to contact the custodian and ask them to recharacterize the Roth IRA contribution as a traditional IRA contribution. Then follow up by converting the resulting traditional IRA to Roth. IMHO, don't offer confusing info like "A rep said I couldn't do this", just ask them to recharacterize the contribution and all earnings. In all likelihood this will work just fine, because whoever does it at the brokerage will know what to do. I believe you can recharacterize up to your filing deadline for that tax year.

As far as the specifics, I don't think the rep is quite right. You have to treat the earnings as pro-rata between your contribution and the total value of the account before the contribution. If you made both the 2021 and 2022 contributions on the same day during Q1, then it would just happen to work out that the pro-rata amount would, indeed, be 50/50. But if you made the contributions at different times, it wouldn't necessarily be 50/50.

Also, in case it isn't obvious, pro-rata is on holdings, not dollar value. If you try to do it manually and calculate the amount as a dollar value, then by the time you enter the trade the holding will have changed value so you're invariably going to overshoot or undershoot. Which is why I would ask them to recharacterize things, because they will most likely just transfer an appropriate share count of the asset between accounts.

OTOH, it's not like the IRS is going to feed all of this into a formula and come after you for a $8.75 mistake. I would be somewhat nervous if the withdrawn amount is less than the contributed amount, but not nervous enough to eat the loss. I'd just keep good records.

Hmm. Something to read:
https://investor.vanguard.com/investor- ... terization
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retiredjg
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by retiredjg »

I don't think either has it right, but my guess is that the rep at your brokerage is probably closer. :?

DRReaders wrote: Sun Feb 20, 2022 3:37 pm The brokerage representative offered this advice which seems incorrect, "Because your overcontribution accounts for half of the total contribution for the account, removing half the current account value (in this case $5,000) would be sufficient." He did specify that he was just speculating and this was just what he thought should happen. It doesn't seem like the brokerage would be able to provide a value of how much I should withdraw to compensate for the $6,000 contribution at the beginning of 2022.
I don't think it will be exactly half because the first contribution has been there longer. So that first contribution already had earnings before the slide to lower values started. Yes, the brokerage should be able to figure this out. This is nothing new.


At the point, no one knows how much your $6,000 contribution has become with gains/losses. You will be penalized by the IRS for the overcontribution because no one knows how much you should be withdrawing."
I'm pretty sure this is not correct. People have frequently reported their brokerages do this for gains so it seems quite possible for losses as well.

I believe someone has also reported their brokerage does not do it so the poster had to do it using some instructions somewhere (I don't know where). I have to think your CPA is just mis-informed on this issue.

If you have no other money in tIRA (including SEP, SIMPLE, or rollover IRA)....and will have no money in any of those accounts until after the end of the year....I would ask them to recharacterize that contribution of ___ on ____ to tIRA and then convert it to Roth by the end of the year. This would be sort of an accidental backdoor Roth contribution, but there should be no tax.

If this is not a good option for you, ask them to return the contribution to you as if it never happened. You will get a 1099 which you should report on your taxes next year, but nothing should be taxable since it is at a loss.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

retiredjg wrote: Sun May 22, 2022 11:35 am
At the point, no one knows how much your $6,000 contribution has become with gains/losses. You will be penalized by the IRS for the overcontribution because no one knows how much you should be withdrawing."
I'm pretty sure this is not correct. People have frequently reported their brokerages do this for gains so it seems quite possible for losses as well.

I believe someone has also reported their brokerage does not do it so the poster had to do it using some instructions somewhere (I don't know where). I have to think your CPA is just mis-informed on this issue.

If you have no other money in tIRA (including SEP, SIMPLE, or rollover IRA)....and will have no money in any of those accounts until after the end of the year....I would ask them to recharacterize that contribution of ___ on ____ to tIRA and then convert it to Roth by the end of the year. This would be sort of an accidental backdoor Roth contribution, but there should be no tax.

If this is not a good option for you, ask them to return the contribution to you as if it never happened. You will get a 1099 which you should report on your taxes next year, but nothing should be taxable since it is at a loss.
I think the rep was saying that the brokerage would not be able to either does not or cannot give me an amount that I should be withdrawing. I asked them to return my contribution and they simply sent me a withdrawal form that I can put X dollar amounts for excess contributions.
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retiredjg
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by retiredjg »

DRReaders wrote: Sun May 22, 2022 4:43 pm
retiredjg wrote: Sun May 22, 2022 11:35 am
At the point, no one knows how much your $6,000 contribution has become with gains/losses. You will be penalized by the IRS for the overcontribution because no one knows how much you should be withdrawing."
I'm pretty sure this is not correct. People have frequently reported their brokerages do this for gains so it seems quite possible for losses as well.

I believe someone has also reported their brokerage does not do it so the poster had to do it using some instructions somewhere (I don't know where). I have to think your CPA is just mis-informed on this issue.

If you have no other money in tIRA (including SEP, SIMPLE, or rollover IRA)....and will have no money in any of those accounts until after the end of the year....I would ask them to recharacterize that contribution of ___ on ____ to tIRA and then convert it to Roth by the end of the year. This would be sort of an accidental backdoor Roth contribution, but there should be no tax.

If this is not a good option for you, ask them to return the contribution to you as if it never happened. You will get a 1099 which you should report on your taxes next year, but nothing should be taxable since it is at a loss.
I think the rep was saying that the brokerage would not be able to either does not or cannot give me an amount that I should be withdrawing. I asked them to return my contribution and they simply sent me a withdrawal form that I can put X dollar amounts for excess contributions.
I think you need to call again. I would not be confident that the rep was correct since so many brokerages do this. Are you willing to share which brokerage it is?

Have you seen this form? Does the form tell you how to calculate how much of the loss is attributable to your last contribution?
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by 123 »

I assisted a relative who made an excess contribution to a Roth IRA at Schwab due to an error in a self-employment income calculation. Schwab had an standard form (available online) to fill out and send in (either electronically or snail mail) which identified the tax year of the contribution and the amount of the contribution to be returned. Schwab did their own calculation of the intervening loss on the account and returned an adjusted amount. I would think that many brokers have similar procedures, it was really very easy to accomplish.
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Alan S.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by Alan S. »

This is the IRS Reg that includes the formula for returned or recharacterized contributions. The IRA custodian should have access to software that produces the calculation using this IRS Reg.

https://www.law.cornell.edu/cfr/text/26/1.408-11

Since there does not appear to be any transactions between the 2022 contribution date and this calculation that would require an adjustment to either the opening or closing balance, the formula should be straightforward.

Since there is an apparent loss, less than 5000 will actually be returned or transferred to a TIRA if you recharacterize. If you then convert to a Roth, the conversion will be less than your TIRA basis, so will be tax free.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

retiredjg wrote: Sun May 22, 2022 4:53 pm I think you need to call again. I would not be confident that the rep was correct since so many brokerages do this. Are you willing to share which brokerage it is?

Have you seen this form? Does the form tell you how to calculate how much of the loss is attributable to your last contribution?
I will try to call again. The brokerage in question is Merrill Edge, and the 3 representatives that I've been in contact have all directed me to the excess contribution form which I have to fill out the X dollar amount myself. Previously I had them disburse $2,500 (half) of my account as excess contributions which should be enough to cover 2022's excess and possibly include some of 2021's contributions. I have not received a 1099 this year yet.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

123 wrote: Sun May 22, 2022 5:19 pm I assisted a relative who made an excess contribution to a Roth IRA at Schwab due to an error in a self-employment income calculation. Schwab had an standard form (available online) to fill out and send in (either electronically or snail mail) which identified the tax year of the contribution and the amount of the contribution to be returned. Schwab did their own calculation of the intervening loss on the account and returned an adjusted amount. I would think that many brokers have similar procedures, it was really very easy to accomplish.
That's what I thought also, but the accountant made the process sound more convoluted. I assumed cause he worked for the IRS previously he knew what was going on.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

Alan S. wrote: Sun May 22, 2022 6:50 pm This is the IRS Reg that includes the formula for returned or recharacterized contributions. The IRA custodian should have access to software that produces the calculation using this IRS Reg.

https://www.law.cornell.edu/cfr/text/26/1.408-11

Since there does not appear to be any transactions between the 2022 contribution date and this calculation that would require an adjustment to either the opening or closing balance, the formula should be straightforward.

Since there is an apparent loss, less than 5000 will actually be returned or transferred to a TIRA if you recharacterize. If you then convert to a Roth, the conversion will be less than your TIRA basis, so will be tax free.
I assume that because the account has a loss, the contribution for 2022 would be about half of the Roth IRA's value, and possibly less than that. Withdrawing half as excess contributions for 2022 would account for that amount + a bit of 2021's contribution.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by Alan S. »

DRReaders wrote: Mon May 23, 2022 8:10 am
retiredjg wrote: Sun May 22, 2022 4:53 pm I think you need to call again. I would not be confident that the rep was correct since so many brokerages do this. Are you willing to share which brokerage it is?

Have you seen this form? Does the form tell you how to calculate how much of the loss is attributable to your last contribution?
I will try to call again. The brokerage in question is Merrill Edge, and the 3 representatives that I've been in contact have all directed me to the excess contribution form which I have to fill out the X dollar amount myself. Previously I had them disburse $2,500 (half) of my account as excess contributions which should be enough to cover 2022's excess and possibly include some of 2021's contributions. I have not received a 1099 this year yet.
If you just took an ordinary distribution of 2500, you will not get the 1099R coded for removal of an excess contribution and the IRS will still look at your 2022 contribution as excess unless your income turns out low enough to avoid an excess.

You should check your MEdge statement to see what type of distribution was processed, but the return of excess always requires an earnings calculation according to the formula I posted earlier. If you simply requested 2500 to be withdrawn ME would not have done an earnings calculation and will not code the 1099R as a return of excess. And what happened to the possibility of recharacterizing instead of withdrawing, and then doing a conversion?

Either a distribution of excess or recharacterization of the excess should be routine for ME to perform. Before doing anything else we need to get all the facts straight about all the transactions. Is the following correct?

1) You opened a new Roth IRA in 2021 and contributed 6000.
2) You then added a 2022 contribution early this year of 6000.
3) Your 2021 contribution is OK because your 2021 income was low enough.
4) You then requested a 2500 distribution, but since it was a dollar amount, ME probably did not code it as a removal of excess, and if they did not, you have not removed any of the excess. Before doing anything else, find out how ME coded the distribution you received.
5) There were no other contributions made to this account, no other distributions, and no rollovers into or out of this account since you opened it - just the 2500 distribution.

You might call MEdge before posting back here and let us know what they indicate about this. Unfortunately, it sounds like your prior discussions resulted in some confusion over what you wanted to do. This is not uncommon, but all they really needed to know was how much of your 2022 contribution was to be returned as an excess contribution and they would have calculated the earnings. If I am correct about the 2500 distribution, then you will need to start over but the computation they make will now have to factor in the 2500 distribution you already took.

One other math problem - when the rep mentioned distribution of half, even though that was incorrect, they intended to refer to half the total account value, not half the 2022 contribution. Therefore, the formula should result in very roughly 5000 returned to you, not 2500.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

Alan S. wrote: Mon May 23, 2022 10:06 am If you just took an ordinary distribution of 2500, you will not get the 1099R coded for removal of an excess contribution and the IRS will still look at your 2022 contribution as excess unless your income turns out low enough to avoid an excess.

You should check your MEdge statement to see what type of distribution was processed, but the return of excess always requires an earnings calculation according to the formula I posted earlier. If you simply requested 2500 to be withdrawn ME would not have done an earnings calculation and will not code the 1099R as a return of excess. And what happened to the possibility of recharacterizing instead of withdrawing, and then doing a conversion?

Either a distribution of excess or recharacterization of the excess should be routine for ME to perform. Before doing anything else we need to get all the facts straight about all the transactions. Is the following correct?

1) You opened a new Roth IRA in 2021 and contributed 6000.
2) You then added a 2022 contribution early this year of 6000.
3) Your 2021 contribution is OK because your 2021 income was low enough.
4) You then requested a 2500 distribution, but since it was a dollar amount, ME probably did not code it as a removal of excess, and if they did not, you have not removed any of the excess. Before doing anything else, find out how ME coded the distribution you received.
5) There were no other contributions made to this account, no other distributions, and no rollovers into or out of this account since you opened it - just the 2500 distribution.

You might call MEdge before posting back here and let us know what they indicate about this. Unfortunately, it sounds like your prior discussions resulted in some confusion over what you wanted to do. This is not uncommon, but all they really needed to know was how much of your 2022 contribution was to be returned as an excess contribution and they would have calculated the earnings. If I am correct about the 2500 distribution, then you will need to start over but the computation they make will now have to factor in the 2500 distribution you already took.

One other math problem - when the rep mentioned distribution of half, even though that was incorrect, they intended to refer to half the total account value, not half the 2022 contribution. Therefore, the formula should result in very roughly 5000 returned to you, not 2500.
Thanks for writing it all out concisely. Yes, this is exactly what happened. 1-5 is all correct.

At this point, the account has $2,500 left in it with $2,500 withdrawn as a excess distribution as you mentioned in point 4.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by Alan S. »

That's the point - I think that the 2500 might have been coded by Medge as an ordinary distribution, not the removal of an excess contribution. The 1099R will be coded J for an ordinary early distribution, while a removal of excess must be adjusted for gain or loss, and you receive the net amount.

Why does the account have only 2500 left in it? What happened to your 2021 contribution? In other words, if both contributions added up to 12,000, and there has been a 20% investment loss in addition to your 2500 distribution, the account should have very roughly 7000 left in it. Or was the 2022 contribution made to a different Roth account than the 2021 contribution?
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

Alan S. wrote: Mon May 23, 2022 12:55 pm That's the point - I think that the 2500 might have been coded by Medge as an ordinary distribution, not the removal of an excess contribution. The 1099R will be coded J for an ordinary early distribution, while a removal of excess must be adjusted for gain or loss, and you receive the net amount.

Why does the account have only 2500 left in it? What happened to your 2021 contribution? In other words, if both contributions added up to 12,000, and there has been a 20% investment loss in addition to your 2500 distribution, the account should have very roughly 7000 left in it. Or was the 2022 contribution made to a different Roth account than the 2021 contribution?
So the total account value was $5,000 when I was asking. $12,000 initial contribution ($6,000 for 2021, $6,000 for 2022) -> $5,000.
$2,500 was removed from this total account value of $5,000 so $2,500 remains.

I just had a call with Merill and this is what came out of it:
I won't be receiving a 1099 for 2022 until the end of the year.

The representative talked with the trading department and said I had to calculate the losses on my $6,000 contribution for 2022 myself or consult a tax professional. They could not do this. (This response has been consistent with all the representatives at Merill I spoke with)

The $2,500 distribution will be coded correctly as a removal of excess because I ticked the checkbox that specifically mentioned this was a removal of excess contributions for 2022. I've attached that part of the form below. When I filled this out previously, I chose option D for 2022, $6,000 for the excess contribution amount, -$3,500 for earnings/losses, and $2,500 for total:
Image
Alan S.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by Alan S. »

OK, Option D is the correct option, but I am shocked that MEdge requires the investor to determine the appropriate gain or loss instead of them doing it like most other large IRA custodians do. Particularly surprising considering the size, history, and capabilities of MEdge.

I also did not expect that your loss would be many times worse than the major indexes. You have a 58% loss here compared to around 20% for the S&P 500 from it's peak. Obviously, if this is correct, you were invested in one or two holdings that have just been hammered, but you should be OK with respect to your 1099R next January.

Accordingly, you have 2500 in cash from removing the excess amount. You could still add 3500 of other money to it, make a new non deductible TIRA contribution of 6000 and immediately convert it to a Roth IRA (back door Roth). You cannot have any other non Roth IRA accountt for the conversion to be non taxable. With a loss of this magnitude, if you have the other funds available (or will within several months), you are much better off than recharacterizing would have been, because you can make a new full 2022 contribution to a TIRA, replacing the loss. You have several months to determine where to go from here with your 2022 contribution, as you have removed the prior contribution.
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retiredjg
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by retiredjg »

DRReaders wrote: Mon May 23, 2022 1:36 pm The representative talked with the trading department and said I had to calculate the losses on my $6,000 contribution for 2022 myself or consult a tax professional. They could not do this. (This response has been consistent with all the representatives at Merill I spoke with)
I had heard there was at least one brokerage that was doing it this way. In my opinion, this is an excellent reason to move your money somewhere else. This is definitely a service they should be providing for you.

Since they don't, the least they should do is direct you to the right formula for figuring it out yourself. They didn't even do that. Shame on them. :(
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by shess »

retiredjg wrote: Mon May 23, 2022 2:58 pm
DRReaders wrote: Mon May 23, 2022 1:36 pm The representative talked with the trading department and said I had to calculate the losses on my $6,000 contribution for 2022 myself or consult a tax professional. They could not do this. (This response has been consistent with all the representatives at Merill I spoke with)
I had heard there was at least one brokerage that was doing it this way. In my opinion, this is an excellent reason to move your money somewhere else. This is definitely a service they should be providing for you.

Since they don't, the least they should do is direct you to the right formula for figuring it out yourself. They didn't even do that. Shame on them. :(
This surprised me, too, so I went and looked at the forms from various brokerages. The results were ambiguous enough that I didn't post. But it did look to me like you could consistently have the brokerage make the earnings calculations if you recharacterized your contribution. For return of excess, some seemed to have the option to specify the amount of the original contribution and they would calculate, whereas others only let you enter a dollar amount.

I kind of find this surprising because you cannot calculate precise dollar amount to withdraw unless you know the pricing of your assets at the point the withdrawal will happen. The discrepancy is likely to be a small amount (a couple days of price movement), and the regulations probably account for that, but to me half the value of having the custodian make these calculations is that they could figure out the number of shares which need to be removed rather than using dollar values.
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by Alan S. »

The NIA formula will produce the dollar value of the recharacterization or contribution return, but the custodian's forms should also allow the IRA owner to specify which assets are to be transferred. For example you could instruct the custodian to transfer a specified number of shares of "X" and to complete the transaction using shares of "Y".

For a return of contribution, generally you should be getting cash with withholding declined, but you could still specify which holdings are to be sold to generate that cash.
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DRReaders
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Re: Roth IRA Over-contribution, can't disburse full initial amount

Post by DRReaders »

At this point, I think I will leave things where they are. The $2,500 distribution on excess contributions I did this year should cover all or close to the amount of my initial contribution for 2022.

Whenever I called the brokerage or a tax professional, it seemed to cause more confusion than it solved. I would switch brokerages, but I'm planning to hit Platinum Honors tier with BofA/Merill so the Roth being with them is fine. I initially used the account in a non-Boglehead way since it was a much smaller part of my overall portfolio, hence the loss, but will just be using it as part of my bond AA in the future.
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