Correct Excess Contribution in Roth IRA Accounts

We realized last weekend after we were done with our income taxes that we, my wife and I, had made excess contributions in our Roth IRA accounts. Based on our income numbers, TurboTax said we were only eligible for $200 Roth IRA contributions in 2006, instead of the maximum $4,000 we made throughout the year. As a result, we will have to withdraw the excess contributions. Among the three options we have, we decided to make the money into a non-deductible traditional IRA as it appears to be the best choice. We can also choose to leave the fund in the account and keep paying 6% tax every year, or get the contributions plus any earnings back in cash, but neither gives us the maximum benefit of tax deferred growth of earnings.

The first step to fix the problem is to choose which fund to unload. For my wife’s account, the choice is quite obvious. She has more than $4,000 in American Century Equite Income Fund (TWEIX), the fund that will soon become a load fund. We never invested in a load fund and will never invest in such a fund, thus it’s an easy decision to sell TWEIX. In fact, I already sold all her TWEIX shares last week and she’s in the process of opening a traditional IRA account and transfer the proceeds to the new account. Part of my wife’s Roth IRA holdings are with Scottrade and the procedure of withdrawing excess Roth contribution at Scottrade is:

  1. Open a transitional account
  2. Complete a Roth distribution request
  3. Remove the excess contribution from the Roth account to the traditional account

As for me, the decision is not easy to make. After transferring most of my IRA assets from Scottrade to Vanguard, I only have one fund (BRSIX) at Scottrade, which has less than $4,000 market value. Besides, BRSIX is also the fund I want to keep. Thus, selling assets in Vanguard account becomes the only choice for me. I currently have four Vanguard funds in my Roth account:

  • Vanguard Total International Stock Index (VGTSX)
  • Vanguard Inflation-Protected Securities (VIPSX)
  • Vanguard Total Stock Market Index (VTSMX)
  • Vanguard Wellington (VWELX)

Though there are overlaps between VTSMX and VWELX, I really like VWELX a lot and since it now needs a minimum $10,000 (when I got in, it was $3,000), I think I will keep it for now. What I could do is to sell some of VTSMX shares, move the money to the traditional account, and buy VTSMX again. However, with this approach, I will have to pay $10 annual fee since the account will have less than $5,000 in asset by the time I make the withdrawal. To be cost-efficient, I think I will have to go with Vanguard funds (Vanguard charges hefty fees for non-Vanguard products), but which one to invest?

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5 Responses to “Correct Excess Contribution in Roth IRA Accounts”

  1. thc |  Apr 22, 2007 at 11:05 am

    I’ve nevery really understood this great aversion to fees that so many novice investors have. Isn’t performanance all that really matters?

  2. Yan |  Apr 23, 2007 at 12:44 am

    Talking about IRA.

    If I were to make an investment before April 17, is it possible to change the type of investment from 2006 to 2007 after it is already made and marked as 2006?

    I had to send two checks for my traditional 2006 IRA in April because I thought the first one got lost. Apparently the mutual fund management received the check so I called the them asking to discard the second check when they receive it. They made a note on the account but I am afraid they may still deposit it.

    My bank charges $30 to stop a check payment, so I wouldn’t want to do it. However changing 2006 to 2007 for the second check would be OK. Any thought?

  3. The Sun |  Apr 23, 2007 at 1:01 am

    From my experience, I don’t think there’s any problem to make the second check for your 2007 contribution. Usually when you make a contribution before the tax deadline, the fund company may ask you which year the contribution is for because it can go either way. However, whatever contributions you make after the tax deadline can only be for the current year. So if the fund company receives your second check after April 17, there’s no reason for them to assume that it is for 2006. To be sure, you may want to call them later to tell them the second check is for 2007. For them, however, they won’t do anything differently whether it’s for 2006 or 2007. It’s just for your own record-keeping so you know you have already made 2007 contributions.

  4. thc |  Apr 24, 2007 at 12:42 am

    The Sun: You need to be very careful giving advice in an area where you have no real expertise. It’s not “just for your own record-keeping”, contributions need to be properly coded at the custodian for proper IRS accounting.

  5. The Sun |  Apr 24, 2007 at 1:16 am

    thc: Thanks for your comments.

    Actually, I never meant to give anybody any advice because I am not a professional and I don’t know enough to give an advice. I can only say from what I know and my own experience, which sometimes is limited. As for this case, when I make IRA contributions before the tax day, I always remember to write on the check which year the contribution is for. If sometimes I forgot, my broker Scottrade would call me for clarification. I don’t know exactly what happens at the custodian, but of course they will have records for the contribution year of the fund, as you said for IRS accounting purpose, and I think that’s why my broker calls me every time when there’s a confusion and that’s also the reason I told Yan to give them a call to make sure everything is right. For me, as a contributor, nothing changes on how the money is invested.

    “Just for your own record-keeping” may not be very accurate in this case, but other than that, is there anything else that’s inappropriate or wrong in my answer? If you did notice, please let me know so I can correct it.