The Wall Street Journal-20080202-Ask Encore - Focus on Retirement
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Full Text (646 words)Handling Excess Contributions to Your Roth IRA
What happens if you accidentally hit the income limit for contributing to a Roth IRA? Is it easy to remove the excess Roth contribution that you've already made?
Lauren Murphy
Springfield, Mass.
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I am confused about the definition of "income" for the Roth IRA income limit. My wife and I are currently retired and have only investment, pension and Social Security income. Can we still contribute to a Roth IRA? Is the income defined by a W-2, or can these other income sources be used?
Stanley E. Zeitz
Surprise, Ariz.
There are income limits for contributing to a Roth individual retirement account. But if you go over them, you can "recharacterize" your contribution as a traditional IRA contribution or simply withdraw the money, says Ed Slott, a Rockville Centre, N.Y., IRA consultant. And yes, you have to have at least some earned income to make a Roth contribution.
First, the income limits: For tax year 2007, you can't make a full contribution to a Roth IRA of $4,000 (or $5,000 if you're 50 or older) if your income exceeds $99,000 for an individual or $156,000 for a married couple filing jointly. For 2008, the maximum contribution amount rises to $5,000 (or $6,000 if you're 50 or older), and the income limits are $101,000 for an individual or $159,000 for couples filing jointly. If your income exceeds those limits, you may still be able to make a partial contribution to a Roth, which is explained in the Internal Revenue Service's Publication 590 at www.irs.gov.
When you're making a Roth contribution, the IRS looks at your "modified adjusted gross income," which is basically all your income except for income from any Roth IRA conversions and a few other exceptions, Mr. Slott says. Publication 590 includes a work sheet on page 61 explaining how to calculate this amount.
And yes, you must have earned income -- either from a job or self- employment -- to contribute to a Roth IRA. The IRS defines compensation as including "wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also includes commissions, self-employment income, and taxable alimony and separate maintenance payments."
If you make a Roth contribution, and then your income for the year winds up exceeding the limit that applies to you, one option is to recharacterize the contribution as a traditional IRA contribution.
To do so, you generally have the contribution transferred from the Roth IRA to a traditional IRA using what's called a trustee-to-trustee transfer. If you make the transfer by Oct. 15, 2008 (for a 2007 contribution), you can treat it as having been made to the traditional IRA instead of the Roth.
Be sure to notify each IRA custodian that you are doing a recharacterization, include any earnings in the transfer, report the recharacterization on your tax return for the year in which you made the contribution, and treat the contribution as having been made to the traditional IRA on the date it was actually made to the Roth IRA.
You can also withdraw your original contribution with no penalty, because "with Roth contributions, you can pull the money out at any time tax- or penalty-free," Mr. Slott says. You would have to pay a 10% penalty and tax on any earnings, unless you are at least 59 1/2 years old and have had your Roth open for at least five years.
Whatever you do, don't leave the money in the Roth. "That's an excess contribution, and there's a 6% penalty, an excise tax, on any amount that's an excess contribution," he says.
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