February 26, 2020 at 9:47 am #5275DABU1989Participant
I have made $1,000 excess contribution to my wife’s 2019 Roth IRA on Feb. 4th, 2020. She is 52 years old. Schwab customer service informed me that there is no need to pay federal and state income tax on “earnings” as it is a Roth IRA. But, when I did some Google search, I read a document from Wells Fargo Advisors (ready to share with members; clear and concise). It indicated that we need to pay federal and state income tax on the “earnings.” Money is parked in a money market account. The IRS provides a specific formula—Net Income Attributable (NIA)—that must be applied to calculate earnings or losses attributable to an excess contribution.
Schwab will compute “Earnings Calculation for Excess/Recharacterized Amount.” My questions are: 1) do we need to pay taxes on the “earnings” when we transfer excess amount from Roth IRA to a brokerage account? 2) Should I instruct Schwab to withheld federal income tax on the “earnings” based on our effective tax rate from 2018? For state income tax, Schwab will apply withholding (if required) at the minimum rate based on the laws for our state of residency as determined by the legal address of record on our account. We don’t want to pay any penalty. Please provide your comments and suggestions. Thanks for your help. With regards, Dabu.February 26, 2020 at 6:06 pm #5282Alan S.Participant
If the excess is withdrawn by the due date with earnings, the earnings will be taxable in the year the excess contribution was made (2020). The taxable amount will also be subject to the 10% penalty. Perhaps Schwab did not understand that an excess contribution was being removed, since their answer suggests they were referring to the earnings status once the Roth became qualified.
Definitely DECLINE any withholding on the excess removal. If nothing is said, the IRA default withholding rate of 10% will be withheld (or perhaps a pre specified rate used previously) and the amount of earnings is too small to mess with withholding.
In fact, with recent market losses there might be a loss and therefore no earnings to be taxed or penalized. You will get a 1099R next January coded to indicate that earnings (if any) are taxable in 2020 even though the contribution was for 2019.
It is possible that state withholding is mandatory, but that would only apply to a very few states. Suggest you specifically decline state as well as federal withholding and Schwab will then advise if your state has a withholding requirement.February 28, 2020 at 10:03 am #5296DABU1989Participant
Alan: Thanks for your reply and also for the clarification. You are correct about IRA default withholding rate. Schwab is required to withhold 10% from your gross distribution for payment of federal income tax unless you choose not to have federal income tax withheld. I will go with 10% for federal and about state, Schwab will do computation based on our mailing address. In addition, there will be 10% penalty on earnings. Since it is ROTH IRA, our “contribution” will not be taxed.
You also suggest “Suggest you specifically decline state as well as federal withholding.” Please look at the following info from Schwab. It is confusing. Should I mention 10% for option 2? Please clarify. Have a good weekend. With best wishes, Dabu.
“Federal Income Tax Withholding: Schwab is required to withhold 10% from your gross distribution for payment of federal income tax unless you choose not to have federal income tax withheld. You may elect not to have withholding apply to your distribution by selecting the option below and signing and dating this form. If you elect not to have withholding apply to your distribution, or if you do not have enough tax withheld, you may be responsible for payment of estimated taxes. You may also incur penalties under the estimated tax rules if your withholding and estimated tax payments are not sufficient.
1) I do not want federal income tax withheld.
2) I want federal income tax withheld at the rate of ______________%. (Federal tax withholding must be a whole number, at least 10%, and not more than Percentage 99% when combined with state income tax withholding.)February 28, 2020 at 4:18 pm #5298Alan S.Participant
The earnings will be so small, I would simply decline withholding (Option 1), but you are free to elect 10% or higher if you wish to.
Of course, if there are no earnings, there will be no withholding no matter what % you enter.June 6, 2020 at 4:50 pm #7230Lewis-HParticipant
The IRS imposes a 6% tax penalty on the excess amount for each year it remains in the IRA. … (For 2020, your contributions to a Roth IRA will be limited or ineligible if your MAGI is more than $124,000 ($122,000 for 2019) for singles or $196,000 ($193,000 for 2019) for married couples, filing jointly.)
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