The net income attributable calculation can help you fix and avoid the 6% Roth IRA excess contribution penalty.
You have until the October 15th tax filing deadline, regardless if you filed an extension or not. In fact, if you realized you overcontributed after you filed your taxes but it's still before the October 15th tax filing deadline then you can fix it and file an amendment.
Unfortunately, this method will not work if you are past the October 15th tax filing deadline and you will then have to pay the 6% penalty on the excess contribution. However, the 6% penalty is only on the excess contribution and NOT on the net income attributable.
You will have the 6% penalty every year until you fix the excess Roth contribution or the amount is absorbed. This means, you were eligible to make a Roth IRA contribution the following year and the excess was under that amount. You read more about the excess contribution here.
Full Video Transcript
00;00;00;02 - 00;00;16;26
In this video, I'm going to talk about the Roth IRA overcontribution, that means you put too much money into the Roth IRA and now you need to fix it. So there's really four parts that I'm going to talk about into this video to make sure that if you haven't made this mistake to stay out of hot water so you don't make this mistake.
00;00;17;01 - 00;00;35;16
And if you had made this mistake, well, guess what? We're going to fix it. So the four things that we're going to talk about in this video is, first, I'm going to go over the Roth IRA contribution limits. Then I'm going to talk about the Roth IRA income limits. And third, we're going to talk about how the Roth IRA overcontribution happens in the first place.
00;00;35;22 - 00;00;52;16
So hopefully we don't end up in this position. And, of course, fourth, we're going to show you how to fix it. And I'm going to give you a really simple worksheet that's going to walk you through it. And we're going to go through it in this video as well. So you can make sure that if you have made this Roth IRA over a contribution mistake, we're going to fix it.
00;00;52;16 - 00;01;16;22
But before we do in this your first time at channel or you haven't subscribed, click on the subscribe button at the bottom. My name is Travis Sickle, certified financial planner, helping you reach your financial goals. so the first two points that we're going to go through are the limits. So the contribution limits and the income limits, they are different.
00;01;16;29 - 00;01;40;29
So you need to know them to make sure that you don't fall into this trap of overcontributing. And they're really important if you are using a Roth IRA, thinking about using a Roth IRA or unfortunately contributing too much to the Roth IRA, these are really important limits that you need to understand how they work, because it's not just about knowing what those numbers are and then saying, OK, well, I can put it into the Roth IRA or not.
00;01;41;03 - 00;02;01;28
You need to know how they work because if you don't, you're going to make mistakes along the way or you're going to miss huge moneymaking opportunities so number one, we're going to start with the Roth IRA contribution limits. So if you are under the age of 50, under 50 so 49 and younger, you can contribute up to $6,000 into your Roth IRA.
00;02;02;06 - 00;02;39;01
Now, if you're 50 or older, you can do an additional $1,000 into the Roth IRA, bring your total contribution to $7,000. If you're married, you can each contribute the $6,000 or the $7,000, depending on your age, bringing that total all the way up to either $12,000 or $14,000 depending on your age. Now that is for 2019. Now here's something that's really important for 2020, the guidance hasn't come out yet, but I have seen a lot of content out there that is making the assumption that those contribution limits are increasing for 2020.
00;02;39;09 - 00;03;05;25
So you want to make sure that when you're reading through that that the IRS has actually come out with the new contribution limits which they haven't so far. So if you're seeing $6,500 at the contribution limit for 2020 double-check that because it's not official just yet. If you want to see the other contribution limits to other retirement plans, check the link in the description at the bottom or I'll put it right up here so you can see it.
00;03;05;26 - 00;03;28;29
I go through the full walk-through and all the different contribution limits to the various 401K's, IRAs, Roth IRAs, and nondeductible IRAs. So go ahead and click on that link if you want to learn a little bit more. Now with just the contribution limits, if you had contributed over that $6,000 mark, and you're under the age of 50, then you would have over contributed into your Roth IRA for that particular year.
00;03;29;01 - 00;03;50;02
Now, we haven't got into the income limits to see if you even qualify for that maximum contribution, but that would be an older contribution to the plan. So you want to make sure that we're going to fix that, and that's what we're going to do towards the end of this video. But just want to give you an example of what it looks like if it's over that $6,000 mark or that $7,000 mark then it would be an overcontribution.
00;03;50;05 - 00;04;04;15
That is what we're talking about now. Number two, on the list is going to be the income limits. Now, this is whether or not you qualify to save directly into the Roth IRA. Now, I'm going to pull up the income limits on the screen in just a second. But these aren't the only criteria for whether or not you qualify.
00;04;04;20 - 00;04;28;07
This is just a really big part. So, for example, if you're contributing into a traditional IRA, it's going to affect how much you can contribute directly into the Roth IRA. So the income limits are one more criteria that you have to pay attention to of whether or not you qualify for the Roth IRA. So this is straight from the IRS website, and this is the amount of Roth IRA contributions that you can make for 2019.
00;04;28;21 - 00;04;57;05
And you can see right there married filing jointly or a qualifying widower. Now if you are married filing jointly and you earn as a household under $193,000, you can put the full amount that's $6,000 or if you're 50 and older the additional $1,000 bringing it to $7,000. Now here's where it gets tricky the numbers between your income is between $193,000 and $203,000.
00;04;57;10 - 00;05;18;25
It's what's called a phaseout now it's a straight line going from $193,000 to $203,000 so it's over $10,000. So you literally need to take that $6,000 and divide it by $10,000. So for every dollar, you have to decrease the amount that you can actually qualify into the Roth IRA. This is a huge mistake that a lot of people make.
00;05;18;29 - 00;05;51;26
They think that if you make over $193,000, you don't qualify at all. And that is not true. There's a phaseout. So let's say in an example of $193,000, if you're contributing into it and let's say that you make $198,000 which is halfway between $193,000 and $203,000. So if you make $198,000, that's halfway. So that means you have to go to the $6,000 Roth IRA contribution limit and divide that by two, which would be 50% that means you can only put in $3,000.
00;05;52;05 - 00;06;14;06
So let's say in that example you put $4,000 into your Roth IRA, then that means you would have over contributed by $1,000 in that example for married filing jointly. Now if we scroll down a Mary filing separately, if you make from zero to $10,000, that's the phaseout. So right off the bat, you can't even contribute the full amount into the Roth IRA directly.
00;06;14;06 - 00;06;41;17
Now if you look at a single head of household and Married filing separately with a side note and you do not live with your spouse at any time during the year. So really it's single and head of household. So a single and head of household, that threshold is at $122,000. Now, again, you have to understand that if you make over $122,000 doesn't mean you're automatically disqualified from the Roth IRA it's just a phaseout amount.
00;06;41;21 - 00;07;04;19
And there's other ways of getting money into the Roth IRA, but this is directly into the Roth IRA. So let's say that you made under $122,000, then you can contribute the full $6,000 limit into the Roth IRA or directly into the Roth IRA. So if you did $7,000 by mistake, that would be a $1,000 over contribution that you would need to take out of the Roth IRA.
00;07;04;23 - 00;07;26;10
Now for a single, that phaseout goes from $122,000 to $137,000. So it's a little bit different of a phaseout range. Notice that it's not just $10,000 like the Married filing jointly. This is over a $15,000 so it's $15,000. Simple math, you just have to go through that math again. It's the same math as we went through before for the phaseout.
00;07;26;19 - 00;07;52;14
I'll put a link in the description at the bottom. I did a video specifically on phaseouts, so if you want to go through that to make sure that it's accurate, you're contributing the correct amount into the Roth IRA. You can go through that video. Now, before we get into reasons why this occurs, I want to point out there are other strategies that if you do make more than those income limits, then there's other strategies you might qualify for to take advantage of to get money into the Roth IRA.
00;07;52;22 - 00;08;24;18
It just takes a little bit more work. So you want to take a look at other strategies. If you realize that on the income limit side, you don't qualify because you're earning too much money. So going to the reasons why over contributions to the Roth IRA happens, the number one reason that I see that occurs is when someone starts saving systematically into the Roth IRA, because usually you'll take the full amount, the $6,000 for example, and you divide it by the amount of time that you want to save and almost nobody starts saving exactly in January.
00;08;24;28 - 00;08;44;14
So let's say that you started in February or March, and you just took that $6,000 and divide it by 10 or 11 because you have 10 or 11 months left. Well, by doing that, you can see that if you just set it and kind of forget it, well the following year that means you have contributed too much, so you'll get over those thresholds.
00;08;44;19 - 00;09;01;19
That's the most common reason. Now I just use the example you're thinking, Well, if I just missed a month and I adjusted later on, I'll be fine. That is true. You'll be fine. But if you don't, if you make that mistake, then it'll end up over contributing in the following year. That's probably the top reason I see for the overcontributions.
00;09;02;00 - 00;09;20;20
And the second one, of course, is the income limits. We didn't realize that we were going to earn that amount of money or we got a huge bonus check at the end of the year that put us over that income threshold that we weren't really expecting. While that is nice, it put us over the threshold, so we made the mistake that we overcontributed into the Roth IRA.
00;09;20;20 - 00;09;39;11
And a third reason for the over contributions occurs when you have multiple accounts or multiple Roth IRAs at different firms. And the reason that occurs is because there's a lot of systems and safeguards in place that will say, wait a second, you put too much money into the Roth IRA, but the firms don't know where your other money is.
00;09;39;15 - 00;09;59;10
So if you do happen to have two different Roth IRAs that you're actively contributing into, then you run the risk of actually overcontributing into the Roth IRA. So even if you put in $3,000 into one in $4,000 into the other, neither of those two firms would know what the other is holding unless you told them so right there you have an overcontribution.
00;09;59;12 - 00;10;16;13
Now, you don't have to consolidate the Roth IRA. You can have as many as you want, as many different places as you want. You just want to know that in total you can't contribute more than the maximum amount, whether it's $6,000, $7,000 or a reduced amount. So now it's time to fix this Roth IRA overcontribution mistake.
00;10;16;23 - 00;10;35;27
So in order to do so, we need to take the money out of the Roth IRA. And you might be thinking, wait a second, isn't this just really easy? If I know that I put in an extra $500, I could just take that $500 out. Well, I wish it was that easy. And it might be, but it probably isn't, because you also have to account for the growth.
00;10;36;06 - 00;10;56;15
So that growth portion inside of that Roth IRA, you have to actually take that out as well. That's attributable to the amount that you put in. So if you already have an existing Roth IRA, this is where it gets a little bit confusing. So I want to go through the formula and then I'm going to show you a really quick worksheet to make this super simple.
00;10;56;15 - 00;11;26;02
So there are two parts. There's the amount that you actually put into the Roth IRA and then net income attributable. So that's the growth part that's associated with that contribution that you made. So the formula for the net income attributable, because that's the tricky part, is going to be excess contributions multiplied by total earnings, divided by adjusted opening balance at the opening balance, minus any withdrawals that you might have made.
00;11;26;15 - 00;11;50;12
So that is the net income attributable. Now, it sounds technical, but it's actually a little bit simpler than that and the worksheet is going to make it really, really simple. So you want to make sure that you pull that money out. Now, you might be thinking before we get into that, you might be thinking that what if I put the money in there and I already had investments and I never placed the trades, you still have to do the math.
00;11;50;17 - 00;12;23;18
You can't cherrypick which Roth IRA or which positions inside the Roth IRA are associated with those contributions. You can't do it. You have to look at the account as a whole. They don't care what's inside of the Roth IRA, how you invested inside of the Roth IRA. So if you had, let's say, $5,000 already in the Roth IRA before you made this mistake and it was completely invested, then you put an additional $1,000 going over the contribution limit and you never invested that $1,000 you still have to do this math.
00;12;23;25 - 00;12;49;11
You can't say, well, I didn't invest that contribution. It doesn't matter. You have to look at the entire Roth IRA. So let's go ahead and jump into the math and I think maybe this will help you understand how to calculate it and how it works. So this is the worksheet, and we're going to start from the excess contribution amount so if you've already calculated how much you've already over contributed, so let's say you contributed $2,000 too much into your Roth IRA.
00;12;49;13 - 00;13;11;04
Go ahead and put it in there. So you put the excess contribution amount at $2,000. Then you want to look at line one, which is the balance as of the date of withdrawal. So this is the day that you're pulling this money out of the Roth IRA. So let's say that it grew to $8,000. And the next one that you want to take a look at is line three.
00;13;11;04 - 00;13;29;05
We're going to skip over line two because I'm going to assume that you didn't make any withdrawals. If you did go ahead and put a number in there. It's highly unlikely that you made withdrawals in the same year that you contributed. So then we jump down to line three with the account balance immediately before the excess contribution was made.
00;13;29;18 - 00;13;57;20
So you want to look to the date right before you made that contribution that puts you over the limit. So let's say for our example that it was $5,000 and think have too many zeros in there, $5,000. Perfect. And then for line for the amount of the excess contribution. So that is your $2,000. Now why is it asking again the reason that it's asking again, again too many zeros in there.
00;13;58;03 - 00;14;16;18
The reason that it's asking again is it's trying to figure out or this calculator is trying to figure out how much was already in there, how much did you over contribute and what is the growth because the growth is what we're trying to get at with this calculation. That's the net income attributable to that Roth IRA overcontribution.
00;14;17;11 - 00;14;43;03
Sounds really technical, but this is going to help simplify it. So now that you can see all the numbers are already in there. So the adjusted opening balance was $7,000 so that means there's $1,000 and you can see it right there, total earnings, $1,000. That is the growth portion. So if we're breaking it down $2,000 versus the other $5,000.
00;14;43;15 - 00;15;22;26
So here's how it really breaks down. You had a Roth IRA in this example with $5,000 already inside of it, and you can see it right there on line three. Then you over contributed by $2,000, bringing the total balance to $7,000 and then the Roth IRA grew an additional $1,000 to give it a total of $8,000. So at the bottom you can see the $1,000 is what we have to split up between the previous Roth IRA and what's considered attributable to the excess contribution, which that net income attributable comes out to $285.71.
00;15;23;06 - 00;15;47;18
So we have to pull that amount out because the portion of that $1,000 in growth is attributable to the $2,000 and then you have to also pull out that $2,000. So that brings the total to $2,285.71. So I'm going to throw another example out there. So that was showing if the Roth IRA grew over time, but what if it went in the opposite direction?
00;15;47;25 - 00;16;04;09
And you actually had a loss on it? You don't need to pull out the full $2,000 it will actually be a reduced amount. So let's use that same example. So I'm going to pull it up on the screen here. And we're going to change the total value of this Roth IRA from $8,000. And let's say it went down to $4,000.
00;16;04;28 - 00;16;32;23
In that instance, you can see that it dropped all of the numbers. So the net income attributable is now a loss. So instead of that $2,285 that we had to pull out, we only have to pull out $1,142.86. So if there was growth inside of your Roth IRA, then you need to take out more than your contribution. If there was no growth, then you just need to put in that excess contribution.
00;16;33;00 - 00;16;52;29
And if there was a loss, then you can take a reduced amount out of your Roth IRA to make sure that you don't have any penalties. Now, those penalties, if you do nothing, if you ignore this, the penalty is big. It's 6% of the overcontribution, but it doesn't stop there. It's each and every single year that you don't fix it.
00;16;53;04 - 00;17;13;12
And you can fix this. You just have to do before October 15th of that tax filing year or you're going to get that 6% penalty. Now, if you file your taxes, you're going to need to do an amendment. But if you haven't filed your taxes and say it's January or February and you realize you made the overcontribution, you haven't done your taxes yet, fill out the correct paperwork.
00;17;13;13 - 00;17;39;14
Make sure you take the money out of the Roth IRA that you need to in order to avoid that 6% penalty. If you've already filed your taxes, you're going to need to do an amendment as well in order to avoid that 6% and of course, you're going to take the money out of the Roth IRA. Now, there is absolutely no strategy here for overcontributing into the Roth IRA, thinking I'm going to pay the 6% penalty and we're going to be able to get a ton of money in the Roth IRA.
00;17;39;21 - 00;18;12;08
Don't do it because that penalty happens every year. Until you fix it, you really got to fix it. It's not a strategy that you want to use. There's no strategy involved. There's no opportunity here. It's just a mistake that you can make if you overcontribute. Now, the earlier you catch it, the better off you're going to be but when you're fixing it and you need to either recharacterize it for the following tax year or you realize that you don't qualify for the Roth IRA anymore because your income limits you can look at it back to a Roth IRA and using nondeductible IRA to get money back into the Roth IRA.
00;18;12;15 - 00;18;36;25
So there are some tips or tricks that you can use to still take advantage of the Roth IRA, at basically any income level. So you really want to look at your particular situation and don't just rely on the income limits or the contribution limits as the only things that you should look at contributing to the Roth IRA because you might qualify or there might be another strategy you can actually get money into the Roth IRA.
00;18;37;11 - 00;18;40;29
If you've enjoyed this video, be sure to subscribe and leave your comment down at the bottom.
Download the above net income attributable worksheet to correct your Roth IRA over contributions.
Use the video to learn more about Roth IRA 6% penalty and how you can avoid and fix them.
A complete walkthrough and additional resources are on this page for other methods of fixing the Roth IRA excess contribution.