How to Correct Excess Backdoor Roth Contributions

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Roth IRA contributions are phased out as your income goes beyond a certain limit. However, even when you are over the income limits, a backdoor Roth strategy allows you to effectively contribute to your Roth IRA using a two-step process.

When done correctly, the first step is to make a nondeductible IRA contribution. No matter your income, nondeductible contributions can always be made to a traditional IRA.

The second step is to convert the balance of your traditional IRA to a Roth IRA. Because nondeductible contributions are after-tax dollars, the nondeductible basis can be converted to a Roth IRA tax free. If the nondeductible basis is your only traditional IRA balance, then this two-step backdoor Roth strategy is effectively identical to a regular Roth contribution.

While the backdoor Roth strategy is relatively easy, mistakes can happen. Traditional IRA balances from other accounts can get in the way. If tax preparers are not told all the necessary information, they may file Form 8606 incorrectly or mismanage the nondeductible basis during Qualified Charitable Distributions (QCDs).

Another mistake is contributing too much while performing a backdoor Roth.

Your ability to make nondeductible traditional IRA contributions is never phased out. However, you do still need to have sufficient taxable compensation to justify the contribution.

For example, if a taxpayer only has $3,000 of taxable compensation, they are limited to a $3,000 contribution, even though the IRS contribution limit is much higher. If you contribute more than your personal contribution limitation, then the amount you overcontribute is called an excess contribution.

In this way, it can be easy to accidentally overcontribute if you are self-employed and contribute before calculating the full extent of your business deductions.

An excess contribution to your traditional IRA or your Roth IRA are both relatively straightforward to solve. However, if you have not only overcontributed but also converted your excess contribution to a Roth, then the issue is a little more complicated. You can’t only reverse the excess IRA contribution, because the funds are now in the Roth. And you can’t just reverse the Roth conversion because you also need to fix the excess IRA contribution.

The IRS views this as two separate mistakes.

The first mistake is an excess nondeductible contribution.

If your excess contribution occurred between January and the filing deadline, you may be able to fix the error by recoding some or all of your contribution to a different tax year. For example, if you were doing a prior year contribution, you have the option to recode some or all of it as a current year contribution. This strategy only works if your new contribution total after the recoding is still below your contribution limit for that year.

If you use the recoding strategy to correct the excess contribution, then there is no second mistake. You can call the custodian, ask them to recode your contribution, and your Roth conversion can remain.

However, if you can’t recode the contribution sufficiently to account for all of it, then in addition to an excess IRA contribution, you also have a failed Roth conversion. This occurs when ineligible assets are put into a Roth IRA and coded as a rollover.

A failed Roth conversion is effectively treated as a second excess Roth contribution.

From the IRS standpoint, your so-called Roth conversion was actually just you putting ineligible funds into your Roth IRA. Fixing this requires a call to your custodian to remove the relevant funds.

Between your original transfer and the date you remove it, the value of the funds in your Roth IRA may have increased or decreased if invested in the markets. For this reason, your custodian likely won’t remove exactly the same dollar amount. Instead, they will remove the same percentage of the account that your excess contribution represented on the day it was contributed, per IRS guidance.

If you have a tax preparer, be sure to notify them of any actions you have taken to remedy your mistake and follow their guidance on the topic. You will need to make sure to properly handle any variation between the value of your historical contribution and your ultimate correction on your tax return.

The deadline for correcting excess contributions and failed Roth conversions is when you file your taxes, including extensions.

Although mistakes can be made during a backdoor Roth, there are ways to avoid them and ways to correct them after the fact. While an excess or failed backdoor Roth can feel very stressful to solve, it is a normal and quick fix for your qualified financial custodian.

Photo by Dale Gray on Unsplash. Image has been cropped and rotated.

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Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.