19 May I saved in a Roth but I’m ineligible. What can I do?

Q. I contributed $6,000 for the year 2020 early last year towards the Roth IRA. While using the software to file my taxes, it is suggested to either withdraw my contribution and pay no taxes, or pay a penalty for each year until the contribution is withdrawn because I had more income and was thus ineligible for any Roth contribution. The brokerage account where I have invested has less money now so I would want to wait for the market to improve significantly. Can I withdraw the same amount from my Roth 401(k) account instead? I have contributed in all of 2020 and continue to do so. After all, both are Roth accounts.
— Investor

A. It’s not as simple as you suggest.

But you do have some options.

First, if the amount of the account is less than the amount contributed, you still should remove the amount to avoid the 6% excise penalty, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

To remove the amount, you can transfer the shares “in kind” so that you are not missing out on any price appreciation, which seems like it was one of your concerns, Hook said.

He offered this example: You make a $6,000 Roth IRA contribution in 2020 and purchase $6,000 of XYZ mutual fund. You realize when doing your income taxes that you were not able to make the contribution and need to remove it. However, XYZ mutual fund is only worth $5,500. You should remove the $5,500 from the Roth IRA by transferring the shares out of the Roth to a regular brokerage account. This way you are still invested in the fund.

If you don’t want to remove the excess contribution and you think you may be eligible to make a Roth IRA contribution for 2021, there’s another option, Hook said.

“You can ask the custodian if they will reclassify the excess contribution to 2021 – in essence what you are doing is having them withdraw the funds and then immediately resubmitting them to the Roth as a 2021 contribution,” he said.

Be sure that if they do that they code it as you withdrawing the excess and then immediately making a new contribution for 2021, he said. If not, it will look like you did not cure the excess contribution in time and will be subject to the excise penalty for 2020, Hook said.

Obviously you should not do that if you do not think you are going to qualify for the contribution for 2021.

And no, you cannot withdraw funds from the Roth 401(k) to satisfy removing an excess contribution from a Roth IRA, Hook said.

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This story was originally published on May 19, 2021.

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