Many doctors make a direct Roth IRA contribution, then later in the year realize their income is going to be higher than they thought and that direct contribution isn't going to be allowed. Here's an example from my email box:
Q. I am currently closing out my chief resident year and starting my Cardiology fellowship in July. I am doing my financial plan for next year. Last year I was fortunate to have the opportunity to moonlight and brought in an additional $60,000. Moreover, my wife received a raise and a bonus. Given this, we will be over the $206,000 Roth IRA contribution limit for 2020. I have been making the maximal contribution to our Roth IRAs for the past several years. I have not contributed to her Roth IRA for 2020 but have made the maximal contribution to my Roth IRA earlier this year before I realized that I would bring in this much extra money from moonlighting. I will be utilizing a Back Door Roth for her account so I can continue contributing there but I was curious if there is anything I can do retroactively for my account so I am not hit with any tax penalty.
A. It is really unfortunate since these doctors are trying to do the right thing. They are using a Roth IRA. They are funding it early in the year so there is more time for it to compound. They are busting their butt to get their income up. But then the IRS rules come down on them like a hammer. In fact, this circumstance is really common for people in the first year they do Backdoor Roth IRAs. A lot of people don't realize that anybody CAN do a Backdoor Roth IRA. It's just that high earners (along with people filing Married Filing Separately) HAVE to do a Backdoor Roth IRA. So if there is any doubt at all, do your Roth IRA through the Back Door, i.e indirectly. In fact, in 2010, the first year that the Backdoor Roth IRA was allowed, I did a Backdoor Roth IRA. I didn't have to, though; my income turned out to be lower than I expected that year. If you have no idea what I'm talking about with a Backdoor Roth IRA, read this post first:
The Income Limit
The first thing to determine is whether this post even applies to you. If your income is below a certain amount, you can just contribute directly to a Roth IRA. That amount depends on several things. First, it is a MODIFIED Adjusted Gross Income (MAGI). That number is very similar to your Adjusted Gross Income (AGI). Remember how tax form 1040 works.
The first income line you come to is line 7b, your “Total Income”. When people think about income, this is generally what they think of. The third income line on the form is line 11b. This is your “Taxable Income”. This is what your tax bill is actually calculated from. It is basically your total income minus all of your deductions. In between those two, on line 8b, is another income, your “Adjusted Gross Income”. This is “the line” that people are talking about when they use the phrases “above the line deduction” and “below the line deduction.” If it comes out before your AGI is calculated, it is an above the line deduction. These are deductions such as self-employment tax, self-employed retirement plans, self-employed health insurance premiums, HSA contributions, student loan interest, alimony, tuition, and any IRA deductions. If it comes out after your AGI is calculated, it is a below the line deduction. These are EITHER your standard deduction OR your itemized deductions, like mortgage interest, state/local/property taxes, and charitable contributions. A MAGI is just a slight tweak to your AGI.
Here are the MAGI limits for 2020 for direct Roth IRA contributions. If your MAGI is below the first number, you can just contribute to a Roth IRA directly. If your MAGI is over the second number, you cannot contribute at all. If your MAGI is between the two numbers, you can make a partial direct contribution (most shouldn't bother with this, just do it all through the Back Door).
- Married Filing Jointly: $196,000-$206,000
- Married Filing Separately (and lived with spouse for at least part of year): 0-$10,000
- Single or Head of Household: $124,000-$139,000
If you think you'll be anywhere close to that first number, do yourself a favor and just do your Roth IRA contribution indirectly, i.e. through the Back Door (contribute to a traditional IRA and then convert that contribution to a Roth IRA). Since 2010, there has been no income limit on Roth conversions and there has never been an income limit on traditional IRA contributions, just your ability to deduct them.
So how does a MAGI differ from an AGI? It's a very slight difference. Bear in mind that there are other MAGIs out there. We're only talking about the one that affects Roth IRA contributions here. But to get your MAGI, you simply take your AGI, you subtract some income from it and you add back in some other income to it. The worksheet showing you how to do this is Worksheet 2-1 in Publication 590.
Basically, you subtract income from a Roth conversion and you add income from IRA deductions (not sure why you'd have this), student loan interest (if you are using this worksheet, you probably don't have this), tuition deduction (you probably don't have this), a couple of rare deductions for foreign income/deductions (you probably don't have these), some savings bond interest you probably don't have much of, and some employer-provided adoption benefits. As you can see, for most people your MAGI = your AGI since all of these deductions are pretty rare for the folks worried about this limit for direct Roth IRA contributions. So focus on your AGI. That means if you contributed directly to a Roth IRA but late in the year realized you probably should not have, one easy fix is to get your AGI below that limit by contributing to an HSA or a self-employed retirement plan like an individual 401(k) or SEP-IRA. Note that giving a bunch of money to charity is NOT a solution to this problem because that is a below-the-line deduction.
How to Do an IRA Recharacterization
If you can't get your MAGI low enough, you will have to do an IRA Recharacterization. With a recharacterization, as far as the IRS is concerned it is as though you never made the Roth IRA contribution at all, but made a traditional IRA contribution instead. You don't report a recharacterization separately, you just report a traditional IRA contribution. Keep in mind as you read on the internet about recharacterizations that there used to be two types of them—a recharacterization of a Roth IRA CONTRIBUTION and a recharacterization of a Roth IRA CONVERSION. The second type was outlawed in 2018, but the first one, the one we're talking about today, is still perfectly legal. If you decide you want to undo a Roth conversion these days, you're simply out of luck. Here is how you do a recharacterization of a Roth IRA contribution:
You tell Vanguard (or wherever your IRAs are) to recharacterize the Roth IRA contribution to a Traditional IRA contribution.
Yup. That's it. They take care of the rest. I mean, you can read all about all of the rules in Publication 590 Chapter 1 if you want, but that's basically what they say. Don't believe me? Fine. Here's the IRS instructions:
How Do You Recharacterize a Contribution?
To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee. The notification(s) must include all of the following information:
- The type and amount of the contribution to the first IRA that is to be recharacterized.
- The date on which the contribution was made to the first IRA and the year for which it was made.
- A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA.
- The name of the trustee of the first IRA and the name of the trustee of the second IRA.
- Any additional information needed to make the transfer.
In most cases, the net income you must transfer is determined by your IRA trustee or custodian.
See what I mean? It's just a phone call. Any earnings that the account had in between the contribution and the recharacterization just go over with the contribution. No big deal.
You have until your tax filing date to do this. Most of the time, that's April 15th of the next year. However, the IRS is even more lenient than that. You actually can do this for an extra six months after your tax filing date, but you will have to refile your return.
Where Do You Report a Recharacterization?
If you hire somebody else to prepare your taxes, you can skip this section. If you do it yourself, you'll need to make sure you report this correctly. According to Pub 590, you report it on our old friend Form 8606.
Pub 590 says this:
Actually, that's really misleading. If you read Form 8606, you will see that the only time it ever mentions a recharacterization is to tell you NOT to put it on the form.
So what is Pub 590 talking about? They're talking about this section in the 8606 instructions:
Reporting recharacterizations.
Treat any recharacterized IRA contribution as though the amount of the contribution was originally contributed to the second IRA, not the first IRA. For the recharacterization, you must transfer the amount of the original contribution plus any related earnings or less any related loss. In most cases, your IRA trustee or custodian figures the amount of the related earnings you must transfer. If you need to figure the related earnings, see How Do You Recharacterize a Contribution? in chapter 1 of Pub. 590-A. Treat any earnings or loss that occurred in the first IRA as having occurred in the second IRA. You can’t deduct any loss that occurred while the funds were in the first IRA….Report the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. Don’t report the Roth IRA contribution (whether or not you recharacterized all or part of it) on Form 8606. Attach a statement to your return explaining the recharacterization. If the recharacterization occurred in 2019, include the amount transferred from the Roth IRA on Form 1040 or 1040-SR, line 4a; or Form 1040-NR, line 16a. If the recharacterization occurred in 2020, report the amount transferred only in the attached statement, and not on your 2019 or 2020 tax return.
The bottom line is that you just report this recharacterized contribution on Form 8606 as if it were the regular old non-deductible traditional IRA contribution that you should have made in the first place. You also need to include a statement. What should your statement look like? I would write something like this:
To whom it may concern:
I made a 2020 Roth IRA contribution of $6,000 on March 13th, 2020, because I didn't know about the whole MAGI limit thing when I made the contribution. After becoming smarter, I recharacterized $6,137.14 (original contribution plus earnings) to a traditional IRA on November 4th, 2020, Thank you for helping our country fund its government. You're the best.
Hugs and kisses from your favorite taxpayer,
James Dahle
Seriously. It doesn't say what has to be on the statement, just that there is one “explaining the recharacterization”. You don't even have to tell them why you did the recharacterization. If you had a loss in the account between contribution and recharacterization, no big deal. It's still as though you made a $6,000 contribution to a traditional IRA and THEN it lost money. If you were able to deduct the contribution (you probably can't) you would get a $6,000 deduction. The IRA provider may also send you a Form 5498 (which has the recharacterized amount on line 4), but you don't actually do anything with it when you file your taxes. It's just an informational return.
Reconverting the IRA
Now here is where it gets interesting. You've now fixed your mistake in the eyes of the IRS, going from an illegal Roth IRA contribution to a legal traditional IRA contribution (that is probably not deductible for you). But you really aren't done with what you meant to do, which is put money into a Roth IRA. You now need to do a Roth conversion. You do it just like you normally would as if you had contributed originally to the traditional IRA. You can do it the very next day if you like. You can probably even do it the same day, just make sure there is a paper trail showing the money was actually in the traditional IRA at some point. There used to be a waiting period after a recharacterization before you could do a Roth conversion on that money, but that waiting period only ever applied to the recharacterization of a Roth CONVERSION (which is no longer allowed starting in 2018) NOT the recharacterization of a Roth CONTRIBUTION. So there is no waiting period. Just reconvert convert it and go on your merry way.
I hope this information helps you fix your mistake. Just do your Roth IRA contributions through the Back Door going forward and you won't have this problem again. If you need to fix other Back Door Roth IRA mistakes, check out this post.
How to Fix Backdoor Roth IRA Screw-ups
What do you think? Have you had to do a recharacterization of a Roth contribution? What happened? Comment below!
It’s my understanding that the IRS has pretty explicitly given its blessing to the Backdoor Roth. If that’s the case, why not just remove the direct Roth contribution income limit? Is it because those writing the laws and those enforcing them have different priorities?
Congress has to change that law. It wouldn’t surprise me to see them do that. It also wouldn’t surprise me to see them again outlaw Roth conversions for high earners as it was before 2010. It really could go either way.
As you know, this is not a priority for very many representatives nor senators. So I expect the status quo to continue until another big tax or retirement account bill goes through, which seems unlikely if the Republicans still control the Senate after the Georgia special elections.
So I actually made this mistake this year—not because I was unsure about my income for the year but simply because I wasn’t paying close enough attention to what I was doing when setting up the contribution. I essentially clicked on the wrong account. I realized it within minutes but by the time I was able to speak to a live person at Vanguard they said there wasn’t enough time to cancel the contribution. So I was forced to do the recharacterization and then the reconversion. I will say this was not a straightforward process at all and took quite a few phone calls to iron out. So (at least when working with Vanguard), it’s in your interest to avoid an error like this in the first place.
Also since recharacterization requires a statement to the IRS, I’m sure this will preclude me from filling electronically for this year. That will certainly be an additional annoyance…
What was the problem that required multiple phone calls?
Honestly I can’t remember the details anymore since this was in January. They just didn’t seem to understand what I was trying to do for some reason. I think they have some internal rules about recharacterizations and they asserted that those rules prohibit what I was trying to do. But in my case they didn’t apply. And it wasn’t about the ban on recharacterizing Roth conversions, it was something else. I just remember having to explain to them why the roadblocks didn’t apply to me. Eventually they understood but it took a while.
Jim love the “hugs and kisses” in your sample note! You think the IRS might give an extra tax credit for that?
I’ve never put that in a real letter, but I do usually take a minute to thank them! I figure it can’t hurt.
I funded my IRA earlier in the year, yet there was an issue with my Roth conversion happening in a timely manner. I funded an index fund rather than a money market fund, and incurred a significant increase in the value of the initial contribution. Given the contribution limit of 6k, I moved that to the Roth account for my backdoor conversion. However, I am left with money (~3k) still in my IRA account given the increase in value. What options do I have for this money? Can I still covert it over to the Roth and just incur the income tax on it?
Thanks!
Roll it into the Roth IRA. You’ll owe taxes on $3K.
https://www.whitecoatinvestor.com/17-ways-to-screw-up-a-backdoor-roth-ira/
Do your conversion faster next time and just leave the money in cash until you do.
I made 3 separate $1k Roth contributions in March 2020. I am a graduating resident and got a signing bonus, so now my MAGI is too high for Roth. I recharacterized the $3k Roth contributions last week to traditional IRA, and the total balance of that resulted was $4800 ($1800 earnings). Prior to doing the recharacterization, I performed a traditional IRA contribution $3k, thinking that the $3k Roth recharacterization would bring the total traditional IRA balance to $6k. I was unaware that the earnings would come into my traditional account. It actually does not make this clear when you fill out the IRA recharacterization form on Vanguard. Even the guy on the phone could not tell me how much earnings prior to me clicking the button. Well, now my traditional IRA has a balance of $7800. It’s been in a money market settlement fund for a few days. How should I proceed? Should I do a Roth conversion on $7800? Should I sell $1800 from the traditional IRA, bringing the balance to $6000 prior to doing the Roth conversion?
You’re still okay. You only contributed $6K to IRAs. Just convert the $7800 and you’ll owe tax on $1800. No big deal.
A bit off topic, but do you know if the following would be acceptable to IRS or result in a penalty (if a penalty, what is best way to cure or minimize penalty)
Sole practitioner starts Solo 401(k) in Jan 2020;
Feb 2020 he rolls two legacy IRAs (he has had since 2015 or so) into the solo 401(k);
March 2020 he contributes Max to a traditional IRA he just opened to help him do backdoor Roth conversions each year;
He also helps his wife (who has had her own for profit career – not affiliated w husband or his solo practice – for 15+ years) do this as well;
April 2020 he and his wife both convert their respective Max traditional IRA contributions for 2020 to a Roth through Backdoor;
May 2020 they discover wife had a legacy traditional IRA (from 2012 or so) they did not account for when making backdoor Roth conversion in March and April;
In June 2020 wife rolls traditional IRA into her 401k plan at her W2 employer (in hopes of fixing situation / avoiding pro rata rule on earlier backdoor Roth conversion);
Since this all occurred in 2020 will wife avoid pro rata and any penalties or issues with IRS?
If wife has not cured any problems, what should she do to minimize penalties or problems w IRS?
Thanks!
Yes, it should be fine. Good job catching the rogue IRA before the end of the year. The key is to have $0 in traditional IRAs on 12/31 of the year you do the conversion step.
Thanks for the amazing information. The past two years I began to fall inside the phase out limits. Last year is in the books, but this year I can still do something about it. I have already contributed to $6000 to my ROTH. I believe the right steps would be to recharacterize to traditional and then covert back to ROTH. What I’m unsure about is if the earnings can also be converted or what do I do with them? There is about $2500 in earnings I need to figure out.
Thanks for any further help and insight.
Yes, convert them and pay the taxes due on them.
I have currently been participating in the backdoor ira for the past two years as I have never had a prior traditional IRA only only roth before my income limit grew. I am getting married in 2021 and my fiance has a traditional IRA — would she have to convert all of hers by 12/31/2020 in order for us both to participate in a backdoor IRA in 2021?
No, they’re individual retirement arrangements so what you do doesn’t affect her and you file a separate 8606 for each of you.
Maybe I should write a post on this. I bet I get this question 100+ times a year.
Sorry for another question, but I recharacterizated the $6k + earnings at Betterment. I guess it takes 2 days to settle again before I can convert. I’ll initiate the conversation on the 30th or 31st. If it doesn’t fully complete until after the new year, is that a huge deal?
Also, are there specific steps I need to declare contributions as non deductible, or do I just not claim them on my 2020 taxes?
Thanks again. Amazing site.
No, it isn’t huge.
You just don’t claim them.
Thank you for all of the detailed info on this topic, it’s been incredibly helpful for me! But I think your brief answer above (“No, it isn’t huge”) may be misleading… @XZP84 points out a tricky situation related to recharacterization and Roth conversion occurring after New Year’s Day, which I imagine is common among people who realize late that they’ve exceeded the Roth income limit after contributing all year. I haven’t seen this explicitly addressed in any of your articles or comments. I will share my take, please correct me where I’m wrong!
Rephrasing the original question:
I know I can recharacterize Roth contributions made during the prior year as traditional up until the filing deadline. However, I’ve read elsewhere that conversions must be reported in the calendar year that they occurred. So, if I recharacterize and convert prior-year contributions between New Year’s Day and the filing deadline, what are the consequences for reporting?
My understanding is that I must report the recharacterization this year and report the conversion next year, as follows:
1. This year I complete Part I of Form 8606 for 2022 (year of recharacterized contributions) to report nondeductible traditional IRA contributions. But I do not complete Part II, as the Roth conversion occurred in 2023. As a result, I end up with a basis equal to the recharacterized contributions, regardless of any earnings or losses (say $6000 on Line 3, and $0 on Line 13)
1a. One confusing part of this is Line 6, which asks for the value of all traditional IRAs on December 31 2022. This is very difficult to know exactly as the traditional IRA did not exist until the recharacterization *after* December 31. Can I safely ignore Line 6?
2. Next year I complete Part II of Form 8606 for 2023 (year of conversion) to report the Roth conversion. This gets a little complicated if the traditional IRA has had gains or losses, as you’ve noted many times…
2a. In a perfect world, I convert exactly $6000. I owe no tax (Line 16 = Line 17 = $6000) and my basis is wiped away.
2b. In a less perfect world, I have a gain at the time of conversion. I owe tax on the gain (Line 16 > Line 17 = $6000) and my basis is wiped away.
2c. In the real world of 2022, I have a loss at the time of conversion. I owe no tax (Line 16 = Line 17 < $6000). However, my basis is not entirely wiped away. To determine my new basis, I can complete Part I (even though the Part I instructions tell me not to). In short, Lines 2,3, and 5 are $6000. Line 6 is $0. Lines 8, 11, and 13 are the converted amount including the loss (<$6000), and as a result Line 14 is the amount of the loss, which is my new basis going forward. Again, I guess this is just for my benefit, as I am not required to complete Part I (specifically Line 14). But I am required to keep track of my basis…? This leads to my final question:
Going forward, how do I deal with a non-zero basis in traditional IRA? It seems like all I have to do is remember it exists, so I can report and adjust it correctly the next time I am required to file Form 8606. How do I "use" the basis? Is there only one way, i.e. preventing double-taxation of earnings on nondeductible traditional IRA contributions that are either distributed or Roth converted in the future? And if so, then hypothetically let's say I knew I would never have such earnings again in the future — would that imply that I can simply forget about my basis?
Would love to hear any thoughts or clarifications you might have. Sorry for the long comment and thanks again for all your work on this topic!
1. Your basis is the original contribution to the Roth IRA. With a recharacterization, it’s as though you made the original contribution to a traditional IRA.
1a. That is tricky. The right answer is the value of that $6K that was put into the Roth IRA. If that’s all the money in the Roth IRA, it’s easy to look up what that was worth on 12/31. But if you added it to a Roth IRA that already had money in it, you’ll have to do some math to figure it out. For example, if there was $94K in it when you added $6K to it ($100K total) and the whole thing is worth $90K now, then I guess the amount for 12/31 was $5,5400. ($6K * 90K/100K)
2c. Yes, you’re going to be carrying forward a loss indefinitely on your 8606s. The only way to get rid of it is to let money sit in the traditional IRA next year, let it earn money/go up in value and then convert it after the value is back to basis.
Thank you so much! It’s a big relief to get confirmation that I’ve understood.
One last thing: I have seen you say things like “losses suck because you will carry them forward indefinitely on your 8606s”, “losses can lead to messy paperwork until the end of your days”, etc. (as in your reply above). This sort of gives the impression that I now have to file 8606 *every year* as long as the loss is hanging around, which does sound like a headache. But that’s not actually what you mean, right? I just have to remember my basis and file 8606 only in years where I contribute to a traditional IRA. So, say I’m back under the Roth IRA income limit for the next five years, I can just make those direct Roth contributions and not bother with 8606 until the time comes.
No, I think you’ll need to file it forever until that loss disappears. Sorry.
The good news? It’s not THAT bad filing an 8606.
Seriously if I had one what I would do with my next Backdoor Roth is just pause for a while between contribution and conversion and let it grow enough to wipe out the loss. Maybe it takes a few months or a couple of years, but eventually, you’ll have a small gain and can do the conversion step and go back to normal 8606s.
Sorry to drag this on, but that seems to be at odds with Form 8606 instructions about Who Must File. The list of conditions doesn’t include anything like “You have a non-zero basis in traditional IRAs”. Also the language in the Total Basis Chart (which tells how to find your basis) is like this: “IF the last Form 8606 you filed was for a year after 2000 and before 2022, THEN enter on Line 2 the amount from line 14 of that Form 8606.” So it sounds to me like they don’t expect you to file 8606 every year just to report a lingering basis (and it seems silly in principle, just entering the same amount year after year on Line 14).
Of course, one does have to file 8606 in any year that they make nondeductible traditional IRA contributions (e.g. for a Backdoor Roth). But the lingering basis does not complicate things that much compared to a “perfect” Backdoor Roth with no basis. I think the only difference is that the basis appears on Lines 2 and 14 (and figures into the sum on Line 3).
Anyway I do completely agree that at some point it would be smart to recoup my loss via earnings on another Backdoor Roth in the future (seeing as I’ve already paid tax on that amount). But here I just want to clarify that having a basis in the meantime isn’t really such a hassle. To take it a step further — if I *really* wanted to simplify things, I could probably just accept that I paid taxes on a loss and forget about it. I can’t imagine the IRS would penalize me for forgetting my basis — right? Or am I missing something?
Thank you again for bearing with me! Much appreciated.
Who Must File: https://www.irs.gov/instructions/i8606#en_US_2022_publink25399ed0e169
Total Basis Chart: https://www.irs.gov/instructions/i8606#en_US_2022_publink1000196541
You may be entirely right that you don’t have to file, but I can’t imagine you can not file for 5 or 10 years and then try to use that loss.
We are a couple filing jointly although only one spouse has been working. In general, can there be a benefit of filing separately to creat the opportunity for the unemployed spouse to do a Backdoor Roth convesrion?
Would that usually more than compensate for the higher taxes that will be paid by the employed spouse filing separately?
I don’t see why you would have to file MFS in order to do a BD Roth. You can do that filing MFJ even if one spouse can’t due to a pro-rata issue.
But no, it’s unlikely to make up for the much higher taxes you usually pay filing MFS. Luckily you don’t have to do that.
Thanks! — Just to clarify the question – The income of the one working spouse is high enough to make backdoor Roth unattractive.
We were exploring whether the unemployed spouse could use the current zero income as the basis to convert part of own IRA to backdoor Roth.
But then filing separately boosts current taxes anyway, and makes action unattractive!
I have a feeling you don’t understand something about the Backdoor Roth IRA process but I’m not entirely sure what it is. You see, there is no income above which a Backdoor Roth IRA becomes unattractive.
I think what he is trying to say is that his income is high enough to make converting his traditional IRA to a Roth unattractive because he’s in a high tax bracket (I’m assuming he has a significant balance in his traditional IRA that he is considering converting). Therefore he’s asking if he can file separately and then somehow use his spouse’s lack of income as a means to convert his IRA and incur a much lower tax burden. I don’t think he understands the “individual” part of the IRA, and the fact that you can’t report your own IRA conversion on your spouse’s tax return?
Ahhh…maybe that’s it. But perhaps he can roll it into a 401(k) if that is the case.
Great post! In 2020 I put in 2k directly into a Roth IRA (which should have been BD’d) and 4k into a Traditional and then converted to Roth (BD appropriately). $0 Balance in Traditional at end of year. Hoping not to spend too much time on my 2k error. Would you:
A) Recharacterize the 2k as Traditional and then do a second backdoor conversion.
B) Request excess contribution removal from Roth
Thanks!
Chris
Thanks for this helpful post! One question about earnings: I accidentally contributed $6k directly into my Roth IRA in January 2020, and made $2k in earnings in my Roth before I recharacterized the $6k + $2k earnings into a traditional IRA this month. When I reconvert these back into my Roth IRA, do I have to pay tax on the $2k in earnings from the initial Roth contribution? I don’t have additional earnings from when my money was parked in my traditional IRA. Thanks!
Yes.
Okay, I’m just missing things here, so I think this is an obvious question.
My wife and I (both fellows) got married last year (Sept 2020). We both contributed 6k to our Roth IRA lump sum in January 2020 before we got married, and are now married filing separately for 2020 (for PAYE reasons). This means we’re over the limit.
From what I understand, I need to recharacterize both of our Roths to Traditional IRAs and then convert back to a Roth.
I have succeeded in doing the recharacterization which resulted in ~$6900 in my Traditional IRA (presumably these are the gains on the 6k from January). Of note, I have already performed a Backdoor Roth for tax year 2021.
Do I now convert ALL $6900 in each Trad IRA to the Roth IRA? Or just $6000 (ish, as Vanguard requires me to pick a share amount)? Then how do I “pay taxes” on the excess?
Thank you for all the information here
Yes, all $6900. You’ll end up paying the taxes on your 2021 tax return, probably in the form of a smaller refund if you’re like most people.
Thank you! Yes, in the form of smaller return 😉
Okay, I spoke too soon. I am confused as to whether I should attach a statement stating my recharacterization to my 2020 return or my 2021 return (or both?).
I’ve been bamboozled by the fact that I’m doing this in the wrong year. I tried to find a similar situation on the forum but failed, although I’m sure I’m not the only one in this situation.
They’re 2020 IRA contributions so it all goes on your 2020 return. With a recharacterization you do your taxes as though the contribution was made to the traditional IRA in the first place.
“With a recharacterization you do your taxes as though the contribution was made to the traditional IRA in the first place.”
So my understanding was that you do have to submit some kind of statement to the IRS explaining why the recharacterization happened (which also takes away our ability to E-file). But based on what you stated above, it sounds like I could just do my taxes basically pretending I never did the recharacterization in the first place and have that be the end of it. Is that really the case? I assumed the IRS would receive something from Vanguard showing a recharacterization happened, so I do fear that doing it this way might raise a flag. But maybe (hopefully) I’m wrong?
Yes, you have to include a statement, but that’s the way you fill out the return.
https://www.taxact.com/support/1278/2015/ira-distribution-explanation-attach-statement
Okay I’m back and very stressed about my taxes this year.
To summarize, in March of last year, I recharacterized 6989 of 2020 Roth contributions into Trad, then converted them back to Roth. I did this by talking to Vanguard. I filed with a normal looking backdoor 8606 and a letter of explanation.
This year, I got two 1099-Rs, one for traditional IRA and one for the roth
The 1099 for the traditional has:
1. 13k
2a. 13k
2b. X and X
7. 2 and X
And for the Roth
1. 6989
2a. 0
2b. Neither checked
7. R and unchecked
This seems to imply that I took out 20k in distributions. TurboTax and taxslayer are trying to get me to pay a bunch of taxes on it. What did I do (or am I doing) wrong?
I’m really not qualified to troubleshoot one tax software program, much less two. I’m not sure what you’re doing wrong with your data entry, but you should not be paying tax on anything but the gains if any. You haven’t given me any information at all that would allow me to understand what you did. I assume that the 1099s are correct. I don’t see why you can’t report no taxable income for those two 1099s though. In the first, box 2B is checked. On the 2nd, 2a is $0. So why would any tax be owed?
I think you have a data entry problem into the software. Have you read this post?
https://www.whitecoatinvestor.com/how-to-report-a-backdoor-roth-ira-on-turbotax/
Maybe it will help, at least with Turbotax. I’m still not clear why you’re using two programs honestly.
Thanks, sorry for being unclear. I was using two programs because I did it in TurboTax first using your guide you linked to, so I thought I’d try it in a different program in case it was something about the way I understood the questions.
I paid for TurboTax so I can see 8606, and it shows line 13 (the basis in tIRAs for previous years) as 4k. This was based on the IRA worksheet which seems to show 2k in tIRA basis carryover and 14k in roth carryover. And ends up saying that there’s 10k in taxable conversions on line 59 (from “conversion contributions taxable at conversion”, line 35).
There must be something about the way I’m putting in the 1099s that is making it think it’s taxable. Maybe I just have to do it by hand
I did a backdoor roth for 2021 in 2021, and a recharacterization of my 2020 roth into a trad and then conversion back to a Roth. Somehow now I think it’s seeing all of those transactions as being for 2021? This ends up with it looking like I got 13k distributed for 2021
I can’t do your taxes for you (despite the fact that 5 people a day ask me to), but if I were you I’d go back and check the question where it asks for basis. You almost surely answered it wrong. If you put in your actual basis ($10K or whatever) in that IRA, it should get rid of that $10K in taxable conversion.
James – how did you end up correcting this? In same boat.
Varun,
If you look at the instructions for 8606, it tells you where to get your “basis” from. I went back to last years 8606 and saw my basis, and put it in. That seemed to work, as Jim suggested. Sorry, on my phone right now so can’t look at exactly what I did (after hours of messing around).
Are you also having to refile your 2020 return based on the $6989 R code?
I am not. I think I did it right by sending the letter last year. We’ll see I guess? I don’t think I have to refile but I really don’t know
I was afraid of that. Hopefully H&R Block allows the statement to be included with e-file too. Thanks for the info.
Can you comment on the tax treatment on the earning from the recharacterization please? Specifically whether the earning count towards the contribution limit? Let’s say for year 2020, $6000 contribution was made to Roth IRA. But turn out I am over $1000 based on MAGI. I called Vanguard and they recharacterizated the $1000 plus $100 earning to non deductible traditional IRA. My accountant thinks I am $5000 Roth + $1100 traditional IRA = $6100 so I need to remove the $100 since I over contributed. (and subject to 10% early withdraw penalty since I am under age 59.5) The IRS publications did not seems to talk about treatment of earning, just that they need to be recharacterizated together with the excess contribution. It’s kind of open to anyone interpretation. Any thoughts on this will be greatly appreciated.
Thanks!
Karen
PS Recently started reading your book, thank you for your work on educating the HCP.
It’s taxed at ordinary income tax rates in the year of the conversion.
But the earnings do not count toward the contribution limit. It is as though you made the original contribution into the correct account.
Your accountant is wrong.
Thank you so much. Your example is very detailed and informative. You have helped me and couple of friends who are in similar situation. I followed the steps mentioned above.
1. March 16 – Called vanguard to pull excess contribution for Roth contribution 2020 – $4700 plus earning $1000 total 5700
2. March 18 – called back again to VG, put 5700 to Roth as back door Roth contribution.
Now I am filling form 8606. Do I need to fill 2 8606 forms , 1 for re-characterization and 1 for back door Roth? Can you please explain?
I think you just do one. You treat it as though you had made the original contribution correctly.
Thank you.
I have one additional question.
When we are filing taxes for 2020, I still need to show my $1000 as earning when doing the back door ..
Where does that $1000 go on 1040 form? Or do I just add 1000 to my AGI?
It goes from Form 8606 onto the 1040.
Hi – I had to recharacterize a 2019 contribution in 2020 and also performed the subsequent conversion in 2020. In my 2020 Form 8606 – do I need to include the 2020 conversion amount + my $6K contribution for 2020?
Additionally, there was $526.66 in earnings as part of the recharacterization. From the other comments, do I need to include this as additional income on my 2020 1040 form?
Your 2020 8606 documents any IRA contributions done FOR 2020 and any conversions done IN 2020.
I recharacterized $6000 that I contributed to my Roth IRA to a Traditional IRA. Because I contributed and invested in an index fund in February, there’s been earnings.
1. Should I recharacterize $6000 + any earnings from that $6000 or just the $6000?
After recharacterizing, I want to convert to a Roth IRA (perform a backdoor).
2. Do I need to sell this index fund so that my traditional IRA only has money in a monkey market fund in order to perform the backdoor?
Thank you!
1. Yes
2. I’m not sure if that’s required or not. I generally only do Roth conversions on cash but I bet it can be done “in kind”. You can ask Vanguard. But no big deal to liquidate investments, convert, then buy them again as no capital gains due on the sale.
Hi, thank you for your informative post. I googled around but don’t see my specific question, but your comment about converting “cash” seems applicable.
I also accidentally contributed directly to an existing Roth IRA on Jan 1 (shows in account on Jan 3); it went to a cash account. I realized my mistake right away and recharacterized (shows in account on Jan 6). However, as the market dropped between that time, I ended up losing value on my cash contribution somehow. Fidelity says it’s because IRA rules dictate that they have to look at the Entirety of my Roth IRA ($90K) and consider the proportional loss for the cash contribution. It wasn’t a big amount but still an unpleasant surprise. I didn’t realize earnings and losses apply to money that’s left as cash. Is there any other consideration for such a mistake in the future, beside waiting for an upward trend? Thank you !
Yes, that’s the way it works. I’m sorry. You could try to “fix” it next year by leaving the money in your traditional IRA until it has an equal gain before converting.
As a small follow-up to the above. An unexpected late year bonus put me above the income limits for the Roth so that I am in the phase-out stage. I am only allowed to contribute $3600, but I had contributed the full $6000. Last week, I recharacterized the $2400 into my tIRA, then waited a day, then converted it back to my Roth. Because the investments for the $2400 overage was made later in 2021, and the market has gone down, my (re)converted balance is $2385, leaving me at a $15 loss. What are the complications of having a loss when emptying the tIRA as a conversion to Roth?
Losses suck because you end up carrying them forward every year on your 8606. Maybe next year invest the money in the traditional IRA for a week before you convert and make sure you have a little gain before doing it. Then you can wipe out that loss to clean up your paperwork.
Also in this same situation regarding the market going down before the recharacterization went through. Even though the 2022 contribution money was in cash the whole time, Fidelity performed the loss/gain calculation on the entire Roth account and only could recharacterize ~$5,900 of the $6,000. And yes they phrased it like that, that I requested $6k to be recharacterized but due to the calculation, only ~$5,900 actually was recharacterized. So the remaining $100 is still just sitting in cash in the Roth, which I guess makes sense since otherwise where would it go.
I *think* I will still be in the Roth income phase out range this year, so can I just report it as if I did the $5,900 as you typically would for the backdoor Roth and then $100 directly to the Roth (which isnt reportable on personal taxes)? If I am in fact over the Roth income limit, what exactly would I do here? The part that is throwing me off, is that the $100 is still sitting in the Roth and apparently unable to be recharacterized, so I cant report that in the back door Roth conversion since it was never in the Trad IRA at all. I dont know if I am following you with carrying the loss forward, but it seems a little different than what I am describing.
No, it’s as though you contributed $6K to a traditional IRA and it is now worth $5,900. You didn’t contribute anything to the Roth. Ignore the $100 in the Roth. You’re not over the $6K total contribution limit.
Assuming you now convert that $5,900 to a Roth IRA, your 8606 form will carry forward that $100 loss indefinitely.
Hi WhiteCoatInvestor,
I usually directly contribute to my Roth IRA at the beginning of the new year, but this year I’m unsure if my MAGI will exceed the MAGI limits.
Will there be any issues if I did a backdoor Roth early in the year, assuming I will exceed the MAGI limits by the end of the year, but actually end up making less than the MAGI limits? If I do end up making less than the MAGI limits at the end of the year do I need to do a recharacterization to show the IRS that it should have been a direct Roth IRA contribution? How would you go about this?
Thanks so much!
Mel
No, that was my situation the first year I did a Backdoor Roth IRA in 2010. I ended up not actually needing to, but it still works fine. Anyone can do it via the Backdoor process. Low earners can contribute directly instead.
Great! Thank you!
Thank you so much for this very helpful information. I will try and make this short and understandable.
.Just started trading at the very end of 2020, everything was green couldn’t lose. Early 2021 my wife and I added to Ruth’s for both 2020 and 2021. My wife also converted an old 401k to the truth for $10,000. She had 22k in her Roth. Feb 2021 rolls around and we’re losing everything. She has $2500 now. We both made much more than normal last year and it looks like we may be over the limit for a Roth in 2021. We need to recharacterize, but she’s lost almost everything. I am up about 2k from my original 12k but there was so much trading I don’t know how to find what the 2021 6k did.
1. With my wife’s who lost almost 20k of the original 22k, jumbled up as well, what if anything do we recharacterize?
2. How do I find what my gains are from my hodgepodge of trading before I learned how to invest?
3. Do I just need to get with a tax master?
Thank you for all you do.
1. $20K of the original $22K? What are you guys doing? Whatever it is, stop it. Stop “trading” and start investing for the long term. You’re right that recharacterizing with a loss is even more of a pain than having to pay taxes on gains. But it happens all the time so there is a way to properly report it. Basically, when you recharacterize, it’s as though you put the money into a traditional IRA originally. So if you have $500 left of the original $6K, then it’s treated as though you put $6K into a traditional IRA and lost $5,500 of it. Easy peasy. It just gets more complicated if you then convert it to a Roth before it grows back to basis. But you can do it. You’ll just be carrying forward that loss for years on your 8606.
2. It’s all looked at pro-rata.
3. Probably.
Thank you so much for your help! Could I double check one thing with you, please?
I had an excess Roth contribution in 2021, learned about it in 2022 while doing my taxes and had it recharacterized to a traditional IRA in 2022, with the earnings. I understand that this goes on the 2021 taxes, which I’m currently doing in 2022.
I also immediately converted the new traditional IRA (with no other funds in it) back into the Roth.
It sounds like the conversion is totally separate and does NOT appear on the 2021 taxes (which I’m currently preparing). Instead, I’ll report conversion on the 2022 taxes, which I’ll be preparing next year, in 2023?
Just wanted to be sure I got that right before I submit anything. Thank you again!
That’s right.
Thank you! And, thanks again for the work you do here… your postings have been a huge help in figuring out how to deal with the excess contribution this year.
My situation is similar to Nancy’s (and I think also Ryan’s in #23 below). In 2021, I contributed $6000 to my Roth IRA. Then later in 2021, I realized my income would put me in the phase out range, but I wasn’t sure where, so I waited until I started doing my taxes now in March 2022 for my 2021 return before I initiated the recharacterization process now that I know exact $. I need to recharacterize $3000 of my 2021 Roth contribution to be a traditional IRA contribution (and let the earnings/losses on the Roth contribution tag along)…Fidelity is working on this right now and it should be done before I submit my 2021 return. Then later in 2022, I’ll do the backdoor conversion of everything in the traditional IRA (sitting as cash) back to the Roth.
1. What $ do I need to make sure is on my 2021 Form 8606? The $6000 original Roth contribution, or the $3000 amount that exists as the remaining direct Roth contribution after the recharacterization?
2. Because I am recharacterizing $3000 of my 2021 Roth contribution as a 2021 traditional IRA contribution, do I need to say to H&R Block that I contributed $3000 to a traditional IRA? I think yes, but just confirming. I don’t think I report a Roth contribution on my 2021 return?
3. I am currently using H&R Block software, and I don’t think they are letting me attach a statement about the recharacterization (unless I’m missing something). Should I switch to a different software to make sure a statement is included, or just let it be?
4. I’ll report the conversion back to Roth in 2023 on my 2022 return per earlier confirmation…I assume Fidelity will give me a 2022 1099-R for this?
5. Are there other things I need to report on my 2021 return? I’m trying to make sure I do the right steps to avoid needing to file an amended 2021 return (and 2022 for that matter).
6. Because my $3000 incl. earnings/losses of my original 2021 Roth contribution are recharacterized as cash in my traditional IRA account and then in 2022, I’ll convert this whole amount back to the Roth IRA, should I have basis in any of my IRAs for 2021 or 2022?
Thank you for all of this information you’ve amassed! It’s truly been helpful as I feel like I’ve thus far been navigating in a mostly black box.
1. It’s as though you contributed $3K to a traditional IRA in the first place and $3K to a Roth IRA in the first place. So line 1 is $3000
2. Yes. If it asks, sure you can mention the $3K you put in a Roth IRA. Won’t affect your taxes of course.
3. I’m sure there’s a way to do a statement or you can mail it in separately maybe.
4. Yes
5. Report all 2021 contributions and any conversions done in 2021.
6. Not sure what you’re asking. What line of what year’s form are you asking about specifically?
Thanks! I made an error on asking #6…I was confused about different things and didn’t ask a coherent question.
Thank you for your informative post.
I also contributed $6k into my Roth account and then realized I had past the income limit to contribute without taxes. I recharacterized the funds into my traditional IRA on vanguard, but unfortunately I experienced some losses on it (about $400). When it was recharacterized, it came back into my traditional IRA in the holdings they were in. I saw on your article on how to fix a backdoor roth (https://www.whitecoatinvestor.com/fix-backdoor-roth-ira-screw-ups/) that I should have put it into a money market fund or left it in a money market, but again, I didn’t know I would have to do a backdoor roth so I had put it into investments. Do I still need to put the traditional IRA funds into a money market fund before converting it to my Roth IRA, or should I just convert it with the losses? Is there a way my tax accountant can finagle the 8606 Tax Form so I can have that $400 back?
Thanks again!
No, not really. It’s not that big of a deal at this point. The reason to do it is to avoid gains/losses but you’ve already got that.
Might be best to wait until it grows back to basis before converting to make your paperwork easier.
Thanks for the great post! I have one question though:
I am in the process of filing 2021 tax right now
I made a mistake and directly contributed $6000 to ROTH IRA in 2021 (my income went over the limit)
So I just did ROTH IRA recharacterization to my traditional IRA last week (amount of $4700 since I lost some due to investment)
For tax form 8606 line 1, what number should I put?
line 1 says to enter money I contributed to T-IRA… will this be 6000 (what I contributed to ROTH originally) or 4700 (what’s recharacterized to T-IRA) in my case?
$6000
I’m working on filing my taxes via TurboTax (online version) and was hoping you might be able to help clarify whether I am filing correctly. I apologize in advance for the lengthy post.
My wife and I each contributed $6000 to our Roth IRAs at the beginning of 2021 and (fortunately) we had an unexpected gain in income due to my moonlighting, putting us over the MAGI limit. We performed recharacterizations to traditional IRAs and performed conversions back to Roth. This is our first time doing backdoor Roth IRAs.
Now, as I am filing via TurboTax, I am getting some “errors.”
To elaborate on the situation, here are some numbers:
I contributed $6000 to my Roth IRA. I had about $1116 in earnings prior to the recharacterization. Therefore, I recharacterized $7116. I think I probably had the traditional IRA in some sort of fund rather than cash so it did incur some losses prior to converting back to Roth. The conversion was $7074. As I understand from other posts, I will owe taxes on $1074 of that conversion. My first question where on form 8606 are you reporting these losses? (Sorry, TurboTax doesn’t seem to be guiding me through this part).
Now, on to my main questions. In TurboTax it says “Enter your total Roth IRA contributions for 2021, even if you transferred, or ‘recharacterized,’ some or all of it to a traditional IRA.” I input $6000.
The next question states “How much of the $6000 that you contributed to this Roth IRA did you switch, or ‘recharacterize,’ to your traditional IRA.” Do I put $7116 (which would seem a little funny since that obviously is more than the original $6000) or do I put $6000?
I have tried doing both options to see what happens.
If I put in $6000, I don’t have any errors/warnings. My concern with entering just $6000 in this box is simply that my attached statement indicates I recharacterized $7116 (original contribution plus earnings) so I wasn’t sure if this is misleading/confusing at best or fraudulent at worst.
If I put $7116, I get an warning that states:
Because you made an excess contribution of $1116 to your traditional IRA, you will owe a 6% penalty ($66) each year that excess money remains in the IRA.
But don’t worry. You can remove this penalty by taking action before April 18, 2022.
Enter any excess contribution that you withdrew before April 18, 2022.
If I put in $1116 here, then my calculated taxes are the same as if had entered $6000 for the recharacterized amount. Alternatively, if I put $0 here (which may be appropriate since I didn’t actually withdraw the contribution, I merely converted them back to Roth IRA?), then would this somehow be showing that I have excess contributions going forward and I’ll continue to be taxed year after year?
My wife’s tax situation is very similar so I’ll leave out her specific details to avoid belaboring the point.
Figuring out how to file properly has been a bit of a nightmare but I guess on the bright side, I now have a much better understanding of how to do backdoor Roth IRAs in the future without royally screwing it up.
Thanks for your help and all you do for this community!
I’ll leave it to Jim to double check this, but the way I see it, your contribution amount is $6000 and your recharacterized amount is also $6000. Yes in actuality you recharacterized more than that, but the question you’re being asked is how much of your original contribution you recharacterized, not the total amount.
Good question. I think it’s $6K. Basically, you’re saying you recharacterized the whole thing. But this is a Turbotax question not an IRS question, so call them if it doesn’t work out when you do that.
Thank you for the information. So I did the recharacterization for the first time today, for this year contribution . It hasn’t been processed yet. My question is, if I’ll receive the stocks I Recharacterized in the traditional IRA or I’ll receive the $6k amount in the settlement fund?
Not sure exactly what your situation is.
I don’t think investments HAVE to be liquidated to do a recharacterization, but it is probably frequently done.