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What to do if you wrongfully contributed to a Roth IRA

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We all make mistakes, we are human after all. There are so many rules and regulations surrounding personal finance that it’s hard to get it right all the time. In this article, we’ll talk about one of the more terrifying mistakes, which is actually quite easy to fix!

The contribution & the problem

So there you were, on your couch feeling motivated while reading the Wealthy Idiots and missed the paragraph that talks about the income limits on Roth IRA contributions. We’ve all done it. You were so motivated that you immediately sent $6k to your Roth IRA at the broker of your choice. You were excited, and rightfully so.

Later in the week, your friend at work is asking how you are able to use a Roth IRA since you’re a single neurologist and clearly your income is over the IRS-specified limit. You immediately turn pale, wondering how big the tax fine is going to be and how difficult it is going to be to fix this. Luckily for you, this isn’t that big of a deal!

The fix

You may have heard of something called the backdoor Roth IRA. This is a process of first making “non-deductible” contributions to a Traditional IRA, and then converting those contributions to a Roth IRA at a later date (normally 1-day or greater). These contributions are now in your Roth IRA just as they would have been by contributing directly.

But first, you need to fix the situation in the paragraph above. To do this, you’ll need to contact your broker and ask for a ‘recharacterization’ of contributions to a Traditional IRA. This essentially erases your Roth IRA contribution and makes it look like you contributed to a Traditional IRA all along. Once complete, you can then covert the funds your Roth IRA, successfully executing the Backdoor Roth IRA process. Yes, it really is this easy. Note that your individual experience may vary based on broker.

Income limit reminder

For 2022, the income limits are as follows:

If filing single or head of household, your Modified Adjusted Gross Income (MAGI) must be below $129k in order to fully contribute to a Roth IRA. From $129k to $144k, there is a phaseout which can be found here.

Married filing joint has a MAGI requirement of $204k or below to fully contribute. There is a phaseout between $204k and $214k.

If you don’t meet the income limits above, or even enter the phaseout range, it would be best to complete the Backdoor Roth IRA process. Why risk being forced to recharacterize later in the year?

Keep saving

While this may seem like a bump in the road, it’s not. If you keep saving early and often, these little inconveniences will disappear from your memory. Investing can, and will, become automatic if you stay motivated and focused. So, if you need to execute a Backdoor Roth IRA, you’ll likely feel much more comfortable the next time around and soon after, you won’t even realize you’re doing it.

If you start this journey now, you’ll certainly look back in 20 years and be glad you did.

Author

  • D.C. joined the Marine Corps right out of high school. When he left active duty after 5 years of service, he quickly earned a bachelors degree and an MBA. He got his first private sector job at a modest salary and quickly worked his way up through promotions. Once he started making decent money ($38k at the time), he quickly realized he needed to learn how to save for his future. After nearly ten years of research and application, he wants to share his knowledge and financial best practices so more people can become Wealthy Idiots!

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