I have a Roth IRA brokerage account I opened well over 5 years ago, it had been sitting at a $0 balance for a few years after using money from it as part of buying a first home, I was not contributing to it after the home purchase because I was working up to max’ing my 401K and HSA contributions.
In 2019/2020 I was able to max 401K and HSA so I ended up contributing max to the Roth IRA each year – total $12,000.
In early 2021 the stocks I bought in the Roth IRA account had lost money (leave it to me to manage to lose money in stocks between 2020 and 2021), given my success w/ 401K and HSA I decided to sell everything in the Roth IRA and remove the ~$9500 remaining balance – I believe(d) this was no tax/penalty because the amount was less than the original contribution amounts and the account was over 5 years old.
This year I learned there are caps on income for Roth IRA contribution eligibility – not sure how I managed to have that gap in knowledge, but I did – and I now realize that in 2019 and 2020 our household income was too high to be eligible, meaning all $12,000 that went in during 2019/2020 would have been considered excess.
My understanding is that you owe a 6% penalty for excess contributions for each year the excess exists (w/ exceptions for removal before filing).
My questions to the board are:
Since my account is at $0, did I defacto remove the excess inadvertently and stop penalties? Or from the IRS’ point of view does that excess condition still exist despite there a $0 balance in the account, and I’m still accumulating penalties?
To date I haven’t heard from the IRS about this, I realized this error myself. I certainly don’t want to do anything wrong by the IRS, and if I owe a penalty for my mistake I will pay it, but I also don’t want to open a can of worms and screw myself – I’m no pro, I’m just a dope who struggles through Turbo Tax each March – I have no idea how I’d go back to remedy this situation short of proactively hiring an accountant / tax pro for who knows how much money, so I’m wondering if my best course of action is to simply wait for the IRS to send me their calculation of the penalty and then pay it?
Since my account is at $0, did I defacto remove the excess inadvertently and stop penalties? Or from the IRS’ point of view does that excess condition still exist despite there a $0 balance in the account, and I’m still accumulating penalties?
Yes, you’ve removed all the excess contributions - can’t remove anything more if the account is at zero.
Maybe you need to talk to the brokerage to make sure they do the paperwork to report it as a return of excess contribution.
BTW - How was the account >5 years old, but you only put in the $12k during 2019 and 2020? Had you previously emptied it down to $0 pre-2019?
With your account at $0, I do not think there are any additional penalties the IRS can have for you for 2021 or going forward.
So at most I think your penalties are $360 for 2019 + $720 for 2020.
FWIW, you probably could have contributed to your Roth via the “Backdoor Roth”.
A backdoor Roth contribution is really easy to do if you don’t have a traditional IRA (so don’t have any pre-tax money in a traditional IRA)
If you find yourself in similar situation in future (or even for 2021 tax year), I encourage you to look at doing a backdoor Roth.
In early 2021 the stocks I bought in the Roth IRA account had lost money (leave it to me to manage to lose money in stocks between 2020 and 2021), given my success w/ 401K and HSA I decided to sell everything in the Roth IRA and remove the ~$9500 remaining balance – I believe(d) this was no tax/penalty because the amount was less than the original contribution amounts and the account was over 5 years old.
I will point out that contributions can be withdrawn immediately with no taxes or penalties. There is no 5 year wait for withdrawal of contributions - the 5 year wait is only for qualified withdrawals.
This year I learned there are caps on income for Roth IRA contribution eligibility – not sure how I managed to have that gap in knowledge, but I did – and I now realize that in 2019 and 2020 our household income was too high to be eligible, meaning all $12,000 that went in during 2019/2020 would have been considered excess.
If you have no other pre-tax IRA money, you actually could have made after-tax contributions and then converted to a Roth IRA. Of course, conversions do have a different 5 year clock, and you would have run into issues with withdrawing those conversions early.
Since my account is at $0, did I defacto remove the excess inadvertently and stop penalties? Or from the IRS’ point of view does that excess condition still exist despite there a $0 balance in the account, and I’m still accumulating penalties?
You’ve stopped additional penalties for overcontributing. You do have a penalty of $360 for your 2019 contribution. Depending on when in 2021 you took the money out, you may have penalties for both the 2019 and 2020 contributions.
I’m no pro, I’m just a dope who struggles through Turbo Tax each March – I have no idea how I’d go back to remedy this situation short of proactively hiring an accountant / tax pro for who knows how much money
With your account at $0, I do not think there are any additional penalties the IRS can have for you for 2021 or going forward. So at most I think your penalties are $360 for 2019 + $720 for 2020.
Closing the account in early 2021 before the tax return was due would have eliminated the penalty for 2020.
The IRS is seriously behind on processing returns. Paying an accountant would cost more than allowing the interest to accumulate. It is possible that any amendments would not be processed before the IRS would contact you.
The amount of the penalty isn’t trivial. It was a mistake that has been corrected. I believe that the IRS interest rate on unpaid taxes/penalties is 3%.
The IRS has no authority to waive penalties on overcontributions but have some authority to waive interest.
Personally, I would just wait for the IRS letter then pay the penalty and request waiving of the interest because of not understanding the income restriction and the excess contribution was accidently corrected with closing the ROTH IRA.
Appreciate all the quick responses in this thread!
It sounds like the general consensus is that by bringing the account to a $0 balance I inadvertently stopped the penalty accumulation, and that I’ll likely owe $360 times either 2 or 3 depending on how the IRS views the sitaution (and the exact dates).
If interest is 3% I think I’m OK with that, it’s still cheaper than hiring a professional to proactively sort it out – I’m just glad I didn’t fall into some sort of an error/trap that would lead to my owing $720/yr until I made elobrate filings to prove otherwise – would be adding insult to the injury where I managed to turned $12K into $9,5K
I’d also further assume that if I haven’t heard from them about this within 3 years of the filing deadlines for the years where a penalty was due I probably will never hear from them?
