What You Should Do If You Find Out You Weren't Eligible to Make That 2015 Roth Contribution | Ed Slott and Company, LLC

What You Should Do If You Find Out You Weren't Eligible to Make That 2015 Roth Contribution

By Beverly DeVeny and Jeffrey Levine
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This week's Slott Report Mailbag answers a few inquisitive readers on what to do if you just found out you aren't eligible to make a Roth conversion or contribution in a given year and if you can name a trust as an IRA beneficiary. As always, we recommend that you work with a competent, educated financial advisor to keep your retirement nest egg safe and secure. You can find one in your area here.

1. I just found out I was not eligible to make a Roth conversion/contribution. What do I do now?

Answer:

First and foremost, you will have to remove the funds from the Roth IRA. You have three options.

  1. Recharacterization - The funds can be recharacterized to a traditional IRA up to October 15 of the year after either the year of the conversion or the year for which the contribution is made. You must notify both the Roth IRA and the traditional IRA custodians that you are doing a recharacterization. A net amount is recharacterized. Gains or losses on the account for the time the funds are in the account that are attributable to the contribution/conversion must also be recharacterized. The funds must be moved in a trustee-to-trustee transfer back to an IRA. Once this is done, the funds are treated as though they had always been in the IRA.
     
  2. Excess Contribution – This option can be used either before or after the October 15 date. If it is before October 15 of the year after either the year of the conversion or the year for which the contribution is made, then again a net amount must be withdrawn. The IRA custodian should be told this is a withdrawal of an excess contribution. The funds will go into your pocket and will no longer be in an IRA. Any earnings that are withdrawn will be taxable for the year of the contribution/conversion, not the year they are withdrawn. If the October 15 date has passed, this will be your only option for removing the funds. However, you no longer have to calculate gains or losses. You only remove the amount of the contribution/conversion. This is good if you have gains in the account, bad if you have losses. You also will have to pay a 6% excess contribution penalty on the amount of the contribution/conversion that was in the account as of December 31 of the prior year. This penalty will also apply to a contribution made up to April 15 of the current year that was designated as a prior year contribution. The penalty is reported on IRS Form 5329, which is filed with your tax return. The penalty will apply for each year that the excess amount remains in the account (that is why you need to remove it as soon as possible).
     
  3. Carry Forward – You can carry forward the excess amount and use it up in subsequent years as contributions for those years. This is generally only a good idea for contributions when you are fairly certain that you will be eligible to make a contribution in the next year. You will still owe the 6% excess contribution penalty for each year that you have excess funds in the account.
     

2. My IRA beneficiary is a minor. Can I name a trust as the IRA beneficiary?

Answer:
Yes, you can name a trust as the beneficiary of your IRA or Roth IRA. BUT, do not do this unless you understand all of the ramifications of having a trust instead of an individual inheriting the IRA. Always consult with an IRA expert advisor before taking this step. NEVER, NEVER, NEVER move your IRA assets into the trust or retitle your IRA into the name of the trust. Both of those actions are taxable events and you will owe income tax on the entire balance in your IRA and you will no longer have an IRA!! The trust should simply be named as the beneficiary on the beneficiary form.
 

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