Withdrawing excess Roth IRA contributions in declining market

[free4now]

I made a $4000 contribution to my Roth IRA in November 2007, but now that I'm doing my last minute tax filing scramble, I just found out that since I had no earned income for 2007, my contribution is an "excess contribution" which I wasn't supposed to make. Stupid beginning retiree mistake. Doh.

So it looks like the best thing for me to do is to withdraw the excess contribution of $4000 so I don't have to pay a 6% penalty on it every year. The deadline for me to do this is April 15 (next Tuesday!)

The wrinkle is that because of the market downturns, part of my contribution is now gone. I've contributed $4k in 2006 and $4k in 2007, but my Roth account balance is now only about $7500, down from $8200 on 12/31/2007.

All the info on this situation I can find on the web seems to assume a rising market, where I would withdraw the whole contribution and pay a 10% penalty on the interest on that contribution. But what to do when there is no interest and depending on how you look at it, the $4k contribution may not even be fully there?

Should I just withdraw a fixed $4k amount?

I'll give Vanguard a call but they aren't tax advisors so I'm not sure they will be able to give proper advice.

[crazy connie]

Check with these guys: Fairmark Forum
They are a board manned by CPA's. In fact I think this same issue came up earlier this week. Looks like you got some company!

[free4now]

Thanks Connie I found a thread on that forum that addressed it pretty well. It turns out it's not up to me to specify the amount of the distribution. I just fill out the Vanguard "IRA and ESA Excess Contribution Removal Form" with the amount of my contribution ($4k), and they will calculate the distribution amount when I mail that in. Unfortunately they won't be able to process the form by April 15, and even if they could they wouldn't send the 1099-R (which officially notifies me and the IRS of the distribution) until January of 2009. So I'll dummy up a 1099-R with an approximation of what would have gotten distributed, and report that on turbotax. Since there aren't any earnings (this market downturn may simplify things!) there's no need for me to get it exactly right.

[OAG]

Originally Posted by free4now

Thanks Connie I found a thread on that forum that addressed it pretty well. It turns out it's not up to me to specify the amount of the distribution. I just fill out the Vanguard "IRA and ESA Excess Contribution Removal Form" with the amount of my contribution ($4k), and they will calculate the distribution amount when I mail that in. Unfortunately they won't be able to process the form by April 15, and even if they could they wouldn't send the 1099-R (which officially notifies me and the IRS of the distribution) until January of 2008. So I'll dummy up a 1099-R with an approximation of what would have gotten distributed, and report that on turbotax. Since there aren't any earnings (this market downturn may simplify things!) there's no need for me to get it exactly right.

Then what do you do in 2009 with the 2008 1099-R? IMHO you should call the IRS to see what you should do. Something tells me 2 wrongs will not make 1 right and in about 18 months you should receive a letter with the IRS label in the upper left hand corner (I hate those).

[free4now]

Originally Posted by R Wood

Then what do you do in 2009 with the 2008 1099-R? IMHO you should call the IRS to see what you should do. Something tells me 2 wrongs will not make 1 right and in about 18 months you should receive a letter with the IRS label in the upper left hand corner (I hate those).

That was my concern too, but I think this is actually the right thing to do for several reasons:

1. I'm actually filing a "substitute 1099-R" (IRS form 4852), which has a line where I included an written explanation of the whole sordid mess. Theoretically a human being will read that and match it up with the real 2008 1099-R that arrives next January. If not, at least there's a paper trail so it's not my fault.

2. The guys who seem to be tax experts on the fairmark forum talk about how to dummy 1099-Rs for these situations.

3. The Turbotax instructions for withdrawing excess contributions actually tell you how to dummy it up, including the codes for box 7 (P and J in my case), and have a wizard step for allowing me to specify that the 1099-R is for 2008 not 2007.

4. The alternative is to file an amended 2007 return later. I absolutely detest amended returns so I'll do anything to avoid it!

[OAG]

Just curious on these "dummy 1099's". Are they prepared due to not receiving a proper 1099-R from some entity that should have furnished one? Do you actually make copies to send to the IRS and the State, if applicable, as normal 1099-R's are distributed? If you send them to the IRS via the signed transmittal form how do you get by the "fraud statement". I could see you making a "replacement" 1099-R for one that you should have received and you are reasonably certain distribution was made by the issuer. Even then wouldn't one just ask for a replacement copy? This "dummy it up" method IMO has all the potential to create a future problem for yourself. Frankly, IMHO, it is your fault, those Fairmark "experts" are IMOH not "experts" unless they do in fact work for the IRS (which they do not as, if the did, they could not comment), as far as Turbotax goes they have made a few major mistakes with their software in the past (remember they only warranty the calculations). IMO a phone call to the IRS (you should not have to give them your name or SSN) would get you a valid response from the ones you need it from.