Withdrawal of excess Roth contributions – what about the earnings?

Example:

Taxpayer contributes $5,000 to his Roth IRA in 2017. The entire contribution is excess and he fails to recharacterize the contribution before the 10/15/18 deadline. In the meantime the $5,000 has phenomenal return and grows to $25,000. Later in 2018 he decides to withdrawal the $5,000 excess contribution in order to avoid the 6% penalty in future years.

I was told that he does NOT have to withdraw the earnings associated with the excess contribution. This seems counter- intuitive to me based on the fact that recharacterizations must include any earnings or loss associated with the excess contribution.

Can anyone provide some clarification or reference regarding this? I find it hard to believe that the $20,000 of growth would be allowed to remain in the Roth.

Thank you much,

-Robert



The 6% excise tax and the removal of earnings are mutually exclusive. By missing the 10/15 deadline, the excise tax was incurred for 2017 but the earnings get to remain in the Roth. In fact, any excess contribution that generates high earnings should NOT be removed by the due date to protect the earnings from taxable distribution plus 10% penalty. The excise tax should be compared with the tax and penalty in making this decision. Also, remember that the earnings % is calculated using the entire Roth IRA performance during the time of the excess, not just the particular investment purchased by the contribution. This example is extreme and in most cases removal by the due date to avoid the 6% excise tax would be preferable.



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