Withdraw or recharacterize contribution?
If someone made a small non-deductible contribution to a traditional IRA account earlier this year ($600 total), can they remove that contribution and instead open a Roth IRA and contribute to the Roth, assuming their income is within proper limits for a Roth contribution? Alternatively, could they remove the contribution from that IRA account and open a separate IRA account specifically for non-deductible contributions, in order to make future RMD calculations easier?
I have researched this and it seems that either a removal, maybe as an “excess contribution”, or a recharacterization to a Roth IRA might be OK.
Thank you!
Permalink Submitted by Alan Spross on Sun, 2011-05-15 17:43
You can either ask for a return of your contribution plus or minus allocated earnings, then make a Roth contribution OR ask that the original contribution be recharacterized as a Roth IRA contribution. If your earnings are negative, removal is probably best since you will get back less and owe to tax or penalty. You can then contribute the original full amount to a Roth or any other amount within the max limit. On the other hand, if you have positive earnings, removal will result in tax and penalty on the earnings. So if the earnings are positive recharacterization is better since the earnings will just be transferred to the Roth IRA.
Note that once you recharacterize the contribution, you cannot recharacterize it again or reverse the first recharacterization (conversions are an exception here).
Whether you are referring to a 2010 or 2011 contribution, the deadline dates for doing the above are obviously one year apart.
Also, trying to keep your TIRA accounts separate according to whether the contributions were deductible or non deductible is a waste of effort because all of your TIRA accounts are considered to be one single account for both tax and RMD implications. Trying to separate them therefore does not change anything vrs using a single account.
Permalink Submitted by Linda Taylor on Sun, 2011-05-15 21:07
OK, good to know. And it’s a 2011 contribution, so I’ll ask for a return of the money. It’s sitting in cash, so no earnings.
Regarding your comment about keeping the regular and non-deductible accounts separate not mattering, it seems that it would be helpful when one goes to take their RMD in later years. Doesn’t the taxation of the RMDs have to be pro-rated based on pre-tax vs after-tax contributions? I know that all IRA accounts are counted as one, but certainly the RMD dollar figures could be calculated separately and then added together. So it just seems like if the non-deductible account is kept separate, then the person will always know that there is no tax on that particular dollar amount. Rather than trying to make a pro-ration every year.
Permalink Submitted by Alan Spross on Sun, 2011-05-15 23:53
Yes, the after tax basis must be pro rated for all distributions including RMDs, but the pro rate calculation includes all of your owned TIRA accounts. It is not a separate pro ration for each account. The RMD can be taken in any combination over the separate accounts, but since the pro rate factor includes all accounts, the taxable amount of the RMD will be the same.
If you read the Inst for Form 8606 which is used to both report non deductible contributions and for calculating tax on all distributions, the taxpayer must use the year end value of all TIRA accounts plus the distributions taken to determine what % the basis is from non deductible contributions and that is the tax free portion of the RMD or other distribution, regardless of which IRA is used to fund the distribution.
Once you start taking RMDs, the pro rate factor stays the same if there are no investment gains or losses in any of the IRA accounts. If there are gains, the tax free % drops, and if there are losses, the tax free % goes up. You have to use an 8606 every year until either all such IRAs are drained or converted to Roth IRAs. This exact same method applies in calculating the taxable portion of a Roth conversion as well.
Permalink Submitted by Linda Taylor on Mon, 2011-05-16 04:24
OK – I’ll have to look at the IRS form to understand. I just always figured that if I have 5-6 IRA accounts (between SEP IRA, regular IRA, and annuities), it would be easier to keep the non-deductible contributions in a separate account. So when the time comes, I’m calculating an RMD on each of the accounts and then totalling them, to withdraw from just one or more accounts as I see fit. With annual increases and decreases due to gains, losses, reinvested dividends, additional contributions, etc…., I guess I figured it would be easier to track the pro-rated portion for tax purposes if I kept it separate. I’ll have to research further so I’ll understand why it’s not necessary.
Thank you so much for your help!