May 12, 2021 at 9:43 am #34437
I am trying to help a friend. She is single, over 50, and would like to do a 7,000 Roth IRA for 2021, but is not certain that she will be eligible.
She is covered by a matching 403(b). We understand that the Modified Adjusted Gross Income limit is $125,000 to be eligible for a $7,000 Roth, with a phase out between $125,000 – $139,999 and ineligible for a Roth at $140,000 or more. Her W2 will be a bit under $125,000 but she will have 1099 income. At this point, she does not know how much.
In early 2022 she will know her 2021 MAGI. Can she wait until she files her 2021 taxes in early 2022 to contribute to a Roth IRA for 2021? Assuming her MAGI is greater that $140,000, what are her other options to contribute $7,000 to an IRA for 2021?
HootzMay 12, 2021 at 4:34 pm #34589
If she makes a 2021 Roth contribution and later finds that all or part of the contribution is excess, she has multiple options:
1) Remove the excess with earnings by the due date, but earnings will be taxable and subject to penalty if under 59.5 on her 2021 return.
2) Recharacterize the Roth excess as TIRA contributions, which in her case will be non deductible. If she has no other non Roth IRA balance, she could simply use the back door Roth to eliminate the income phaseout problem starting right now. She would make a non deductible TIRA contribution and convert it right away tax free. Form 8606 is filed to report the non deductible contribution and the 2021 conversion. This is a two step process to contribute to Roth, but it avoids excess contributions and complex income phaseout calculations every year. Since the conversions would be non taxable, that eliminates the 5 year conversion holding requirement. If she does have pre tax IRAs including SIMPLE, SEP, or rollover IRAs from prior employment, her conversion would be mostly taxable unless she were to roll these other TIRAs into the present 403b. But be aware of the expenses and investments in the 403b because there are many bad 403b plans, and moving low expense TIRA money into these plans is not a good idea.May 12, 2021 at 7:07 pm #34644
Thank you for your post.
I wish that I had more knowledge to be able to follow our thoughts a little better. Currently, she has a 403(b) from her current employer, a Rollover IRA (403(b) from her past employer, a Roth IRA, and a Traditional IRA. All these are at TIAA-CREF, Vanguard, and Fidelity (Roth and TIRA). At the moment, she does not have a nondeductible IRA so no Form 8606.
I am not familiar with a back door Roth but I will look into it. I do understand a nondeductible IRA (one of her two options) and she will need to decide if she wants another type of account. But I think that you are saying that she convert it right away (comingle it with her TIRA at Fidelity) and only need to file Form 8606 for this year. Correct?
Since there is still a possibility (I think remote) that she would be eligible for a Roth IRA, can the decision wait until just before she files her 2021 taxes?
Personally, I like the idea of the Roth if she is eligible or the back door Roth (I am assuming that it ends up as a Roth no differently than the Roth that she has with Fidelity). Also, her Roth at Fidelity is very small in comparison to her 403(b), Rollover IRA, and TIRA, all of which will be subject to an RMD.
Have I provided you any more information to opine on?
HootzMay 13, 2021 at 1:10 am #34773
You may have overlooked by earlier comment “if she does has no other non Roth IRA balance” the back door conversion will be tax free.
But she does have a rollover IRA which is a traditional IRA and another traditional IRA. So her back door Roth conversion will mostly taxable because for tax purposes all her non Roth IRAs are treated as one combined account, and the total of all these goes on line 6 of Form 8606.
A non deductible contribution can be made to the TIRA and is not a different type of account. Any non deductible contributions become a part of the total non Roth balance. This is sometimes referred to as the “Cream in the coffee situation” in which the non deductible contribution becomes an integral part of the entire Roth IRA balance.
Due to these other 2 non Roth IRAs, she is not a good candidate for the back door Roth since the conversion will be mostly taxable.
Yes, she can wait until 2021 taxes are calculated to determine if her Roth contribution is excess or not. If excess, she can request it to be returned with allocated earnings. The earnings would be taxed and subject to penalty if she is under 59.5 at the time of the excess removal.May 13, 2021 at 7:53 am #34922
Again, thank you for taking the time. I am almost there!
If she is not eligible for a Roth, it sounds like you believe that her best option is a non deductible contribution for 2021. Is this correct and I assume that she can make it now if she wants.
To your last paragraph. When I wrote “Since there is still a possibility (I think remote) that she would be eligible for a Roth IRA, can the decision wait until just before she files her 2021 taxes?, what I mean is can she wait until 2021 taxes are calculated to make the 2021 contribution.
HootzMay 13, 2021 at 8:47 pm #35183
Yes, since the deadline for a 2021 contribution will be 4/15/2022, she can wait until she knows if her MAGI allows a Roth contribution for 2021, and then make that contribution by 4/15.
This should prevent additional transactions such as recharacterization or removal of excess, but a year or more is lost before any gains will be earned on the contribution, and that’s more impactful if the contribution is a Roth contribution where gains would eventually be tax free.
The back door Roth would be a better alternative for most, but because she has these other non Roth accounts, the back door will not work.May 15, 2021 at 12:06 pm #35967
Thank you for the clarity!
I agree with you that waiting until 2022 to do a non deductible IRA is lost time for gains on the contribution.
Assuming that she does the non deductible IRA now and in the first quarter of 2022 (before she files her 2021 taxes) the determination is made that she is eligible for a Roth, how do you handle the non deductible IRA that was already done?
HootzMay 15, 2021 at 5:07 pm #36068
In that case, she should recharacterize the ND contribution as a 2021 Roth contribution. Since a recharacterization results in the contribution being treated as if it was a Roth contribution all along, any gains on that contribution become Roth gains. She has until 10/15/2022 to recharacterize the 2021 contribution if she either files her return by 4/15/2022 or files an extension by 4/15.
If there was a loss on her contribution, instead of recharacterizing it she could request a return of contribution, and would receive her contribution less any loss. There would be no tax and penalty on this. She could then make a new Roth contribution of the full amount replacing the lost dollars. Of course, this is two steps instead of one.
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