Roth IRA Inccome Limits ??????

My 26 year old daughter made her 2012 Roth IRA contribution ($5,000) the first week of January 2012 as usual at my urging. Her 2011 income is $79,200 and 2012 income should be about the same.

She is scheduled to get married on July 14, 2012 (yea!) and her husbands income for 2011 is $132,000 and projected to be the same or higher in 2012.

If they file jointly in 2012 they will have a combined income of $211,200.

Does she have a problem here?

If yes what are the options?

Thanks in advance (Alan)

SeattleSun

PS yea real DINKS for sure!



The marriage does look likely to trigger an excess Roth contribution for her. However, if they both maxed out 401k deferrals at 34,000 total when the 212,000 combined income figure was gross income, it would bring their modified AGI down into the phaseout range (173k to 183k). In phaseout, she would get a pro rated contribution limit.

If she does not have a pre tax TIRA currently, one solution might be to recharacterize the Roth contribution as a non deductible TIRA contribution. She could then convert to a Roth IRA tax free and end up back where she is now, ie with a Roth contribution. Unofficial label for this strategy is “backdoor Roth IRA”.

She could also just ask to have the contribution returned with allocated earnings. Earnings would be taxable and subject to 10% penalty.

Either way, there is no rush at this point since the recharacterization deadline is 10/15/2013 for a 2012 contribution. Therefore she can wait until about a year from now to see where their modified AGI comes in for 2012 and then decide on which option to pursue.



Thanks Alan,

1) “if they both maxed out 401k deferrals at 34,000 total” A. Neither of them have 401k at this point. They both “opted out” of the ones offered by their companies I think.

2) We are talking about things that are forecast to happen in the future; a) marrage and b) projected income so how is it “fair” to penalitize her for making an IRA contribution in the past (Jan 2012) that might trigger an excess Roth Contribution due to things that might happen in the future. Yea this is the IRS and it has nothing to do with “fair”.

3) “If she does not have a pre tax TIRA currently, one solution might be to recharacterize the Roth contribution as a non deductible TIRA contribution. She could then convert to a Roth IRA tax free and end up back where she is now, ie with a Roth contribution. Unofficial label for this strategy is “backdoor Roth IRA”. ”

TIRA = traditional IRA ???

4) “recharacterize the Roth contribution as a non deductible TIRA contribution”

Why “non-deductible” ????

Can this be done right now today and avoid any issues or is the horse out of the barn on this issue now that the Roth IRA contribution has been made?

Alan, Given this above information can your explain the options again.



PSS Can they file seperately?



If they are married, they can file married/separate but the tax rates for this filing status are higher than joint and this rarely saves taxes. Also, for regular Roth contributions is reduces the income eligibility range to 0-10,000, so it would effectively eliminate a regular Roth contribution as well.

If they both were not considered retirement plan participants at any point in 2012, they could deduct the TIRA contribution (TIRA = traditional IRA), but would then pay taxes when converting it. The end result would be the same as making a non deductible contribution and converting it tax free. It would also be the same as making a regular Roth IRA contribution. Again, if she has other TIRA accounts in addition to this 2012 contribution, the pro rate rules would make the conversion partly taxable.

The Roth IRA contribution can be recharacterized right away if those income and the marriage are assumed to happen or it can be done later after they are have happened. It can then be immediately converted to a Roth IRA so that any earnings after the conversion date will be in the Roth IRA. One downside to waiting is that if the Roth contributions gains 1,000 before recharacterizing, then that 1,000 will be taxable when the recharacterized TIRA contribution is converted. So the key question is whether she has any other TIRAs at this point which would cause her conversion to be partly taxable.

Eg. If she already has a pre tax TIRA (deducted the contributions) or a rollover IRA of 20,000, if she then recharacterized the Roth contribution as a non deductible TIRA contribution of 5,000, then her TIRA is 80% pre tax (20k out of 25k total). Converting the 5,000 will result in 80% or 4,000 of that conversion being taxable. But if she does not have such other TIRAs, then a non deductible TIRA contribution (from the recharacterized Roth contribution) could be immediately converted tax free.



Alan, “So the key question is whether she has any other TIRAs at this point which would cause her conversion to be partly taxable.”

NO

The multiple senerios you run for cases that don’t apply does confuse me a bit.

So to try to clarify and this is real simple, 1) she has no “defined benefit pension plan” with here company as they don’t have one, 2) she has no Traditional IRA, her only retirment account is a Roth IRA and has already made the 2012 contribution of $5,000.

As for the new husband I am not as 100% sure be possible has a “defined benefit pension plan” but no 401k, TIRA or Roth IRA. Of course that is something that we need to counsel him on given his gross income.

So if you could re-write a brief summary I would be greatful. Keep it simple I am stupid in these matters.

Regards



It’s pretty simple in this case, since she can simply recharacterize the contribution as a non deductible TIRA contribution. Then she immediately converts that to a Roth IRA and end up with her contribution in the Roth IRA. It is the same end result as making a regular Roth IRA contribution.

This is a better outcome then if she could deduct the TIRA contribution because the conversion would then be taxable, eliminating the benefit of the deduction. But the deciding advantage of making the non deductible contribution is that she can remove the Roth funds at any time without tax or penalty. But if the conversion was taxed, then she cannot remove the funds without paying a 10% penalty on the amount withdrawn in the next 5 years.

Therefore, the best course of action is to recharacterize the contribution and then immediately convert it. That way nothing else that happens later in the year can eliminate her getting her 5,000 contribution back into a Roth IRA via conversion. This also takes his participation in any retirement plan out of the equation, because it will not affect what she is doing with this contribution.



OK recharacterize it is.

But how is this done? Thru the ‘custodion’ which is TDAmeritrade.

Can you just call TDAmeritrade and say “recharacterize” that $5,000 or do you really have to set up another account ie a TIRA and then move the money to the TIRA and then move the money back to the Roth IRA.

Does anyone else but me think this is the height of insanity? ie ‘back door Roth IRA’.

Thanks again



If she is with TD for her Roth IRA, it is easier to open a TIRA with them as well. Once that account has been opened, check with TD what form is needed to order the recharacterization. Note that a recharacterization can ONLY be done by direct transfer, not by taking out the money and doing a rollover. In this case, it would be a same trustee transfer within TD. Most brokers require the IRA owner to complete a recharacterization form showing WHAT is being recharacterized (regular Roth contribution here), how much of it (entire amount here), and what assets are to be transferred first. If this Roth holds only the 2012 contribution, then the entire balance is transferred to the TIRA. The conversion back to the Roth IRA can usually be done on line as soon as the funds have reached the TIRA. I am sure their service reps can answer any questions if their on line guidance is not clear.

With all the portability available now between retirement plans, it is inevitable that some of the procedures become conflicted and inconsistent, and this is one of them. Still, it DOES provide valuable flexibility to change a contribution type without withdrawing the money as a taxable transaction.



UPDATE

1) She has opend a TIRA with TDAmeritrade and made no contribution to it.

2) In the same envenlope that mailed the “signed TIRA application” to TDAmeritrade she included a “rechartization form” to move the 2012 contribution of $5,000 from the Roth IRA to the new TIRA.

3) Once I see that done she intends to send in the “Roth Conversion” form in to move the $5,000 back to the Roth IRA.

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Alan,

A more important question I believe is “What should these to DINKS have for a retirment strategy?”

A) Wife: no defined benefit program, 401k opted out so far, has a Roth IRA and is funding it “back door” going forward.

B) Hubsand: has a defined benefit program I believe (Safeway), 401k has opted out so far, has no TIRA or Roth IRA or ???

Combined annual income of $210,000 or so.

I looked at the investment options in both their potential 401ks and they “suck” to say the least. When I worked at a fortune 50 aerospace manufacturer in Seattle a number of my fellow employees quit their jobs and did a “roll over IRA” to custodians like TDAmeritrade of their significant 401ks and then after a month of two when their ex-job got advertized in the paper applied and got their old jobs back. I guess we can call that a “back door rollover IRA” huh.

But back to the orginal question what should these kids do? Contribute to a 401k with no reasonable investment options?



Update on the process. Here is a copy of the e-mail just received from TDAMeritrade.

Dear Miss X ROTH IRA:

At TD Ameritrade, part of our commitment to you is keeping you informed of your account status. So we wanted to let you know that we’ve processed your Internal Transfer request in the amount of $5,288.00. Please review the details below for a summary of your request.

Request type:Internal Transfer
Amount of request:$5,288.00
Fees applied to request: $0.00
Means of delivery: Internal Transfer
Total amount deducted from your account: $5,288.00

Please note that this transaction may be a periodic withdrawal that was previously requested.

If you have any questions, please do not reply to this e-mail. Please e-mail us after you have logged on to your TD Ameritrade account by clicking the “Contact Us” link at the bottom of the home page. (For security reasons, we only provide account information via e-mail when your inquiry is sent from our secure Web site.)

You may also call a TD Ameritrade Client Services representative at 800-669-3900, 24 hours a day, seven days a week. Please enter your account number or UserID when you call to receive the best possible service.

Thank you for choosing TD Ameritrade. We appreciate the opportunity to serve you.

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Q. Why did they transfer $5,288.00 when we specifically requested that they transfer only the 2012 Roth Contribution of $5,000.00

Q. The next step is to do a ‘Roth Conversion” of the $5,288.00 in the new and unwanted TIRA back to the existing Roth IRA?



The Notice appears to be as expected for a recharacterized contribution. Whenever a contribution is recharacterized, any earnings that have been generated on the original contribution must be included in the transfer to the TIRA, and in this case the earnings are apparently $288.

If I recall, she has no other TIRAs and the 5,288 can be converted right away to a Roth IRA. One consequence of the time period that passed here is that the earnings were generated and they will be taxable when the entire TIRA is now converted. Of course, if she was aware of the income income limits, marriage etc she could have made the original contribution as a TIRA contribution and converted immediately and there would have been no taxable part. But doing this now is still better than simply withdrawing the contribution. If the contribution was withdrawn, the earnings would still be taxable and a 10% penalty would apply to them as well. So the conversion should be done soon before there are more earnings in the TIRA to convert.

Next year if joint income will still be over 200k, she should make her 2013 contribution to the TIRA and then convert it right away. That will avoid any earnings build up between the time of contribution and the time of conversion. She can repeat this year after year. This process has been coined a “backdoor Roth IRA” contribution, and you can see why.

She must file an 8606 with her 2012 return to show the TIRA contribution as non deductible as well as reporting the conversion.



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