Best way to transfer current year traditional IRA contributions to a Roth IRA?

Submitted by MosDefNoDoubt t3_z7xqa5 in personalfinance

I contributed $600 to an existing traditional IRA this tax year, and shortly after, I found out about the $68-78k phase out for deductions on contributions to traditional IRAs if you also have a company-sponsored plan (401k). This means that my $600 contribution is not pre-tax, and therefore definitely should have been put it in my Roth.

What's my best option? Optimally, I'd like the funds in my Roth instead while avoiding complicating my tax return to the point that H&R Block no longer considers me a "free" return.

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nothlit t1_iy8mfqi wrote

If you are below the Roth IRA income limit (~$129k) you can ask your IRA provider to recharacterize the contribution as Roth instead of traditional. This is a like a do-over and makes it like the contribution was Roth all along.

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grinch1225 t1_iy8wkq3 wrote

Roth is $144k limit currently, with projections for increase in 2023.

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nothlit t1_iy8x5gr wrote

That's the very top end of the phase-out range. $129k is the bottom end, where your ability to contribute starts to become limited.

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grinch1225 t1_iy8x7ut wrote

Absolutely, sorry for misinterpreting what you were saying!

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Werewolfdad t1_iy8meir wrote

Ask your brokerage to recharacterize the contributions

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blakeh95 t1_iy8mg10 wrote

If this is a 2022 contribution, then you should be able to contact your IRA provider to perform a recharacterization of your contribution. This is an important word that you need to use to let them know what you are trying to do. A recharacterization changes your contribution "as if" it had always been made to the Roth IRA.

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MosDefNoDoubt OP t1_iy8n2dn wrote

I called them (Fidelity) before making this post, and they said I'd be able to fill out a return of excess form and choose my Roth as the receiving account. When I went to fill out the form, my retirement accounts were not actually an option for receipt of funds. Should I call back and request a "recharacterization" of the contribution? Because what you described is exactly what I was hoping was possible.

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blakeh95 t1_iy8nsd5 wrote

Do not submit the return of excess form for this. Directly on the form it states:

>Do not use this form to recharacterize contributions between a Traditional IRA and a Roth IRA. The Fidelity IRA Request for Recharacterization Form should be used.

https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/customer-service/IRA-return-excess-contribution-request.pdf

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MosDefNoDoubt OP t1_iy8o1um wrote

I searched "recharacterize" and found the proper form. Thank you very much. Not a lot of money but it was irritating me that I was essentially locking it for 30 years without even receiving tax benefits.

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blakeh95 t1_iy8oody wrote

Recharacterizing is definitely the way to go, but in fairness you would have received some tax benefit, just not as much as recharacterizing to Roth would give you. (If you aren't interested in the details, no need to read below).

A nondeductible Traditional IRA still grows tax-free while inside the IRA. This is not true for taxable accounts. In other words, every single time you sell inside a taxable account, you'll have to pay some tax on the gains--you don't have to do that for any kind of IRA, even if the contribution was nondeductible.

Second, the nondeductible contribution is still only taxed once. When you start withdrawing from a Traditional IRA and you have nondeductible contributions, those nondeductible contributions come back out tax free. For example, suppose you had $1,000 of nondeductible contributions and a total account balance of $100,000. This means that 1% of your account balance was nondeductible and had already been taxed. Therefore, for every $100 you withdraw from the account, only $99 is taxable. 1% of your withdrawal--equivalent to the 1% of the account that was nondeductible in the first place--is not taxed when withdrawing later.

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MosDefNoDoubt OP t1_iy8wnj1 wrote

That's good to know. Wouldn't have been as irritated had I known that portion of the account wouldn't be taxed. Won't be making this mistake again but at least now I can educate others.

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TheBeatdigger t1_iy8xwtc wrote

I don’t understand this rule even after just reading a full article about it.

So if I make between 68-78k annually AND have a company sponsored 401k then my IRA contributions are not tax deductible?

So what if I make 79k? Why is it a specific range instead of just saying $68k and up?

If I make 68-78k but don’t have an employer 401k then it’s business as usual for the deduction? Or similarly if I have a work 401k but make less than 68k?

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MosDefNoDoubt OP t1_iy9lvxr wrote

The $68k to $78k range is a phase-out. Below $68,000, your entire contribution is deductible (making it the pre-tax contribution most people are used to with traditional accounts). The portion of your contribution that is deductible phases out at incomes between $68,000 and $78,000. At incomes above $78,000, none of the contribution is deductible.

I haven't looked at the phase-out schedule specific to this scenario, but when I looked in regards to the phase-out of the LLC (Lifetime Learning Credit), it was proportional. The phase-out occurs over $10,000 dollars, so 10% or $1,000 above the minimum threshold would make 10% of the contribution non-deductible.

Again, this is only if your employer offers a company-sponsored retirement plan. The numbers are different otherwise.

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thegelatoking t1_iy90b41 wrote

There is a phase out of the amount you deduct from taxes if you have income in that range. Can't remember the specific math but if you're at $68K you can deduct only 5000, if $69K you can deduct only 4000, etc until it's completely phased out to cannot deduct any.

Business as usual if you don't have an employer 401k

PS not exact numbers because I can't remember...but example of how it works.

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