How Do I Correct Excess Roth IRA Contributions?

How Do I Correct Excess Roth IRA Contributions?

 

Co-written by: Scott Christensen & Katherine Li

 

Contributing to a Roth IRA is a great way to receive tax benefits for retirement savers. If you already do or are planning to take advantage of this tax savings vehicle, it is important to familiarize yourself with the rules that govern these accounts. The IRS has put in place strict limits regarding the amount that individuals can contribute to their Roth IRAs, as well as income limits for determining who qualifies.

 

If you are a single tax filer, you must have Modified Adjusted Growth Income (MAGI) under $140,000 in order to contribute to your Roth IRA. The amount you can contribute to your Roth IRA begins to phase out starting at a MAGI of $125,000; if your MAGI is greater than $140,000, you can no longer contribute to the Roth IRA. For those who file as married filing jointly, your MAGI must be under $208,000 in order to contribute. The phaseout range in this case applies to those with a MAGI between $198,000 and $208,000. The maximum IRA contribution in either case is $6,000 for those under 50 and $7,000 for those 50 and older.

 

As a result of these strict limits, it is easy for taxpayers to overcontribute. So what happens when taxpayers contribute in excess of their contribution limit?

 

For every year that your excess contribution goes uncorrected, you must pay a 6% excise tax on the excess contribution. In order to avoid the 6% tax penalty, you must remove the excess contributions in addition to any earnings or losses on that excess contribution by the tax filing deadline in April. To determine your earnings on your excess contribution, you can use the net attributable income (NIA) formula.

 

Net income = Excess contribution x (Adjusted closing balance – Adjusted opening balance) / Adjusted opening balance

 

Note: If you find that you have losses on your excess contribution, you can subtract that loss from the amount of your excess contribution that you have to withdraw.

 

Reasons for Overcontribution

 

  • You’ve contributed more than the annual amount allowed.
    • Remember that the $6,000 and $7,000 dollar maximum applies to the combined total that you can contribute to your Traditional and Roth IRAs.
  • You’ve contributed more than your earned income.
  • Your income was too high to contribute to a Roth IRA.
    • Unfortunately, single tax filers who make $140,000 or more and those who are married filing jointly who make $208,000 or more are unable to contribute to a Roth IRA.
  • Required minimum distributions (RMDs) are rolled over.
    • RMDs cannot be rolled over to a Roth IRA.
      • If it is rolled over to a Roth IRA, the amount will be treated as an excess contribution.

 

Removal of Excess Prior to Tax Filing Deadline

 

If you find that you have overcontributed prior to filing your tax return and prior to the tax filing deadline, you can remove your excess contributions before the tax filing deadline (typically April 15) and avoid the 6% excise tax. However, your earnings from your excess contribution will be taxed as ordinary income. Additionally, those who are under 59 and a half will have to pay a 10% tax for early withdrawal on earnings from excess contributions.

  • Keep in mind that it is your earnings that are subject to an ordinary income and early withdrawal tax, not the amount of your excess contribution.

 

If you find that you have overcontributed after filing your tax return, you can still avoid the 6% excise tax if you are able to remove your excess contribution and earnings and file an amended tax return by the October extended deadline (typically October 15). 

 

Recharacterization 

 

Recharacterization involves transferring your excess contribution and any earnings from your Roth IRA to a Traditional IRA. In order to avoid the 6% excise tax, you would have to complete this transfer process within the same tax year. It is also important to note that you can’t contribute more than your total allowable maximum contribution. Thus, you must make sure that you can still contribute more to your Traditional IRA prior to proceeding with recharacterization.

 

Apply the Excess Contribution to Next Year

 

You can offset your excess contribution by lowering the amount of your contribution the following year by the excess amount. For example, say that you contributed $7,000 to your Roth IRA when the maximum amount that you could contribute was $6,000. The next year, you can offset this excess amount of $1,000 by limiting your contribution to $5,000. You are, however, still subject to the 6% excise tax due to the fact that you were unable to correct the excess amount by the tax filing deadline, but you won’t have to deal with withdrawals. 

 

Withdraw the Excess the Next Year

 

If you choose to withdraw the excess the following year, you will only have to remove the amount of your excess contribution, not any earnings. However, you will be subject to a 6% excise tax for each year that your excess remains in the IRA.

 

These rules can be confusing to navigate which is why we recommend involving your tax accountant or trusted advisor in these situations. We are happy to connect you with a Merriman advisor to discuss your situation.

 

 

Sources:

https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning/correct-excess-IRA-contributions.pdf

https://www.nerdwallet.com/article/investing/excess-contribution-to-ira

https://investor.vanguard.com/ira/excess-contribution

https://www.fool.com/retirement/plans/roth-ira/excess-contribution/

 

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.

 

Making Sense of the WEP and GPO

Making Sense of the WEP and GPO

Do you have a federal or local government pension? Don’t let the WEP or GPO surprise you. The Windfall Elimination Provision and Government Pension Offset, often called the WEP and GPO, are two rules that can leave you scratching your head. Not only do many people find these rules confusing, but they are also often completely overlooked, which may result in a big surprise when filing for Social Security benefits. Unfortunately, this is not one of those good surprises.

What are the WEP and GPO?

The WEP reduces a worker’s own Social Security benefit while the GPO reduces spousal and survivor benefits received from another’s work record, such as a spouse.

Who is affected?

The WEP and GPO affect individuals who qualify for a pension from non-covered (did not pay Social Security tax) employment. These are typically your federal and local government workers, such as teachers, police officers, and firefighters. Whether these jobs are non-covered will depend on the state/employer. Overseas employees may also fit under this category.

For the WEP to apply, the individual must have an additional job with covered earnings (did pay Social Security tax) that qualifies them for Social Security benefits. Thus, the WEP applies to those who have a mix of covered and non-covered employment. Specifically, they qualify for Social Security benefits and receive a non-covered pension. The GPO applies when an individual with a non-covered pension receives a spousal or survivor benefit. Are you scratching your head yet?

WEP example:

Dan works as a public school teacher in California, one of 15 states where teachers do not pay Social Security tax. He qualifies for a pension through the California State Teachers’ Retirement System (CalSTRS). To make extra money for his household, Dan works an additional job during the summer, where he does pay Social Security tax. By the end of his career, he has worked enough summers to qualify for a Social Security benefit. The WEP will reduce Dan’s benefit since he has both a non-covered pension from his career as a teacher and qualifies for Social Security benefits from his summer job.

How will the WEP affect my benefit?

Understanding the details of the WEP is quite complicated. To simplify, the WEP tweaks the Social Security benefit formula, resulting in a reduction of the worker’s Primary Insurance Amount (PIA). The PIA is the benefit amount one would receive at full retirement age. The amount reduced depends on the number of years with “substantial earnings” in covered employment. The Social Security Administration provides the WEP Chart as a reference to understand the potential benefit reductions based on the number of years of substantial earnings. The maximum monthly reduction is capped at $480 in 2020. The amount reduced stays constant for the first 20 years of substantial earnings before decreasing incrementally per year until it is completely eliminated upon reaching 30 years of substantial earnings.

This offers an incredible planning opportunity for those who have already accumulated a number of years of substantial earnings. If you are thinking of retiring and have accumulated 20 years of covered work, it could make a lot of sense to work for ten more years to eliminate the WEP completely. Remember, you only need to have substantial earnings, so part-time work would count as long as you make what is deemed “substantial” in that year. For someone subject to the full WEP reduction and assuming a 20-year retirement, it could be worth more than $100,000.

It is important to note that the reduction is limited to one-half of an individual’s non-covered pension. This primarily comes into play when the majority of an individual’s earnings are in covered employment but have a small non-covered pension. For example, if you had a pension of $600 per month and your Social Security benefit was $1,200 per month, your benefit will not be reduced by more than $300 (half of your pension income).

How will the GPO affect my benefit?

This rule is more straightforward to understand than the WEP. The GPO will reduce an individual’s spousal or survivor benefit by two-thirds of their non-covered pension benefit.

GPO example:

Sarah qualified for a pension of $2,100 per month from a government job. Her husband, Drew, worked as an engineer for a large corporation. Drew applied for his Social Security benefit at his full retirement age and receives $2,600 per month. Sarah applies for a spousal benefit once she reaches full retirement age. This benefit would generally be $1,300 (50% of her spouse’s); however, the benefit is reduced by two-thirds of her non-covered pension. In this case, she would not receive anything since two-thirds of her pension ($1,400) is greater than what her spousal benefit would be.

Let’s say Drew passed away unexpectedly. Sarah would normally qualify for a survivor benefit equal to Drew’s entire benefit of $2,600. Because of the GPO, she will only receive $1,200 since the benefit would first be reduced by two-thirds of her pension ($2,600 – $1,400).

Keep in mind the GPO only applies to the individual’s own non-covered work. If a surviving spouse is a beneficiary of a non-covered pension, their Social Security benefits will not be reduced.

Conclusion

These rules are tricky to navigate and important to understand for those affected. What makes it worse is that your Social Security statement will not reflect the reduction in benefits from the WEP and GPO. This means it requires work and effort on your part to figure out! The Social Security Administration has provided an online WEP and GPO calculator to help with this. It will ask for a birthdate, non-covered pension benefit amounts, and other relevant information to calculate your new benefit factoring in the rule. If you have a family member or friend with a non-covered pension, they may be subject to these two rules. Please forward this on to them or anyone else who may find it useful.

Employee Spotlight | Lowell Parker

Employee Spotlight | Lowell Parker

Scott: How long have you worked at Merriman?

Lowell: I’ve worked at Merriman for 13 years. I started in client services before moving to my current advisor role. I made the switch because I wanted to help people achieve their goals and provide peace of mind along the way.

 

Scott: What do you love about working here?

Lowell: The opportunity to help my clients articulate, achieve, and expand upon their financial and associated life goals.

 

Scott: What’s on your wish list for the next 10 years?

Lowell: To raise my children in a way that they are responsible, give back, and are well rounded. Professionally, I want to continue developing in my career; and now that I’m getting older, I’m excited to help the next generation do well and advance through their careers.

 

Scott: If you could give one piece of advice, what would it be?

Lowell:

“‘Would you tell me, please, which way I ought to go from here?’ said Alice.

‘That depends a good deal on where you want to get to,’ said the Cat.

‘I don’t much care where—’ said Alice.

‘Then it doesn’t matter which way you go,’ said the Cat.”

–Lewis Carroll, Alice’s Adventures in Wonderland

What an amazing quote! My takeaway is that if you have clear direction, you can achieve whatever you set out to do.

 

Scott: Where are you originally from?

Lowell: Issaquah/Preston/Enumclaw, WA.

 

Scott: What’s the weirdest thing you’ve ever eaten?

Lowell: Chicken feet at Dim Sum in Vancouver, BC.

 

Scott: How was it?

Lowell: Awful!  

 

Scott: What’s your hidden talent?

Lowell: I took up the guitar about 20 years ago and have steadily improved. My next level goal is to start playing acoustic sets at local venues.  

 

Scott: What is the last experience that made you a stronger person?

Lowell: Coaching my son’s basketball team. Patience and repetition!

 

Scott: Merriman has employees take the StrengthsFinder quiz so we can understand how to best work with each other. What are your top five strengths?

Lowell:

Achiever: Those with the Achiever theme have a constant need for achievement. Every day they need to achieve, no matter how small. They take immense satisfaction in being busy and productive.

Learner: Those with the Learner theme love to learn. The process, more than the content or the results, is especially exciting for them.

Self-Assurance: People with this strength feel confident in their ability to take risks and manage their own lives. They have an inner compass that gives them certainty in their decisions.

Competition: People exceptionally talented in the Competition theme measure their progress against the performance of others. They strive to win first place and revel in contests.

Focus: People exceptionally talented in the Focus theme can take a direction, follow through, and make the corrections necessary to stay on track. They prioritize, then act. 

 

Source: https://www.gallup.com/workplace/245090/cliftonstrengths-themes-quick-reference-card.aspx

Employee Spotlight | Brian Woodward

Employee Spotlight | Brian Woodward

Scott: How did you come to Merriman?

Brian: My wife and I moved to Spokane in 2015. At the time, I was working remotely for an investment advisor in Seattle which is where we moved from. I left this relationship when they were requiring me to move back to Seattle to work. Our home was in Spokane now. I spent time searching for jobs in Spokane and didn’t know I would find a place as dandy as Merriman to work for. Once I found out Merriman was a Seattle based company in Spokane, it felt familiar to me.  I started working for Merriman in May of 2017.

 

Scott: What do you do at Merriman and what do you love about working here?

Brian: My title is Client Service Account Specialist, but because of the smaller size of the Spokane office, I wear a number of hats. I do a fair amount of Associate Advisor work for the Advisors. I also do some operational and general office management work. I love the culture of Merriman and how the company treats its employees.

 

Scott: What is a fun fact about you?

Brian: We have 16 linear feet of vinyl records. We love checking out used record stores and finding little gems. We have a good-sized selection of popular rock from the 60’s, 70’s, and 80’s. We have a substantial selection of blues and a huge selection of jazz.

 

Scott: What is your favorite food?

Brian: Pizza. It’s the food I can never pass up. If someone says, we’re having a get-together and we’re going to have pizza, then I’m like, “okay, I’m there”. My wife and I are pretty accomplished at cooking. We like to cook and entertain. We belonged to a food club in Seattle, and we have started to build a food club here in Spokane. It’s a way for us to build friendships in the community.

 

Scott: Tell me about your family.

Brian: My wife, Krista, and I do a lot together and love spending time with each other. We got married later in life, Krista was 36 and I was 43. We have now been married for 17 years. My wife is very outgoing, and I like to refer to her greatest strength as social glue. She is the person that connects everyone together, and I love her for it.

 

Scott: Anything you else you would like others to know about you?

Brian: Something else that has been a really big part of our lives is every year for the past 14 years, we get together with a group we call the Gordon Ranch Gang. We like to refer to the members of the ranch gang as our, “family of choice”. The gang is made up of people from all over the country. My sister-in-law has a family ranch in Montana, and we all rendezvous there for 2 weeks during the summer and go fishing, biking, and hiking. It’s an incredible time.

Maximizing Credit Card Rewards for Your Next Getaway

Maximizing Credit Card Rewards for Your Next Getaway

By: Scott Christensen & Jeff Barnett

With summer upon us and your thoughts wandering to visions of paradise, have you questioned how to save money on expensive trips? Major travel expenses like airline tickets, hotel nights and rental cars can push trip costs into the thousands. Travel credit cards are an excellent way to save money while traveling and improve your entire vacation experience. However, no single card is perfect for every traveler. Let’s review the factors that set some cards apart and how to find the best card for your travel plans this summer. So what kinds of rewards can you earn with top travel credit cards?

Understanding Rewards

Unlike cash back credit cards, travel card bounties typically come in the flavor of rewards points or miles. You will earn points or miles for every dollar spent, and some cards offer additional rewards for spending in specific categories like hotel accommodations or restaurants. To choose the best card for you, it’s important to know your major spending categories. For example, a card may offer 3x points for travel and dining, as well as 1 point per dollar spent on everything else. Unless you spend a considerable amount on travel and dining, a different card that offers 2x points on all purchases might help you earn more rewards.

One example we can look at to illustrate rewards differences is if you spend $4,000 per month on a credit card and are also planning a $5,000 trip this year. You could earn 3x points on $5,000 of travel spending and 1x points on $48,000 of monthly spending for a total of 63,000 points that year. However, earning 2x points on your entire budget with a different card nets you 106,000 points. That’s over two-thirds more rewards for using another card!   

Types of Travel Cards

Now that you know how to earn rewards, the next step is examining types of travel credit cards. Travel credit cards feature two main categories of rewards options—co-branded versus generic.

Co-branded cards bear the name of specific airlines, hotels or rewards programs and often have strict rules for redeeming points. For example, you may be limited to redeeming rewards with the card issuer or their program partners. While co-branded cards are less flexible for where you can spend rewards, they often come with other perks. Some cards allow you to get priority boarding, avoid baggage fees, earn double points on brand purchases or have annual discounted hotel stays.

Extra perks can help you feel like a movie star on your next trip, but rewards on other spending like groceries are often less with co-branded cards. If a co-branded card sounds appealing, we recommend checking out how to use multiple cards across all your spending to maximize rewards. Aligning your purchases with credit cards that offer the best reward for each spending category can help you earn more bonuses. Whether you’re using a travel card to earn 3x miles on your next ticket to Maui or buying groceries with a 2% cash back card, researching the best card for each of your major spending categories pays off.

Compared to co-branded travel credit cards, generic cards offer more flexibility and are not tied to a specific travel company. Generic cards may be used for any airline, hotel or cruise without requirements for redeeming your rewards with a specific brand. This is a great option for people who aren’t committed to a single frequent flier program, loyal to any particular airline, or always stay at the same resort. With a generic card, you can choose travel options that fit your itinerary, even when surprises pop up (like missing the last boat for the night and being stuck staying in the hotel across from the dock, don’t ask how we know). If a generic card fits your style, check out whether your card of choice offers valuable perks like trip cancellation or rental car insurance coverage. Co-branded cards are not the only plastic with awesome perks.

Evaluating Card Benefits

Once you narrow down your travel card options, evaluating other benefits like sign-up bonuses, low annual fees and higher value rewards can help you make the best choice.  

  • Sign-up bonuses can be worth hundreds of dollars and may be the deciding factor between two cards.
  • Annual Fees offset rewards. You will need to assess if your spending level justifies the potential benefits from higher fee credit cards.
  • Point Valuations determine how much you get from your reward points. A point on one card or a specific reward option might not be as valuable as rewards offered by another card or different redemption choice.

When you’re thinking of backpacking through Yosemite or hiking up to Machu Picchu, travel credit cards are a great way to save money on your next trip. Credit cards are valuable tools, but it’s also important to use credit wisely and be wary of carrying a high-interest balance. We recommend reaching out to a Merriman advisor if you have questions about credit, spending, or other ways to enhance your finances. We are here to help and offer guidance throughout your financial journey.