Fixing a Roth IRA Snafu

Editor's note: This is the transcript of Kiplinger Editorial Director Kevin McCormally's commentary on the April 10 broadcast of Nightly Business Report.

I've heard from a surprising number of Nightly Business Report viewers who make too much money ... too much, that is, to contribute to a Roth IRA. Unfortunately, they made this discovery after they made the contribution. Now what do they do?

You can't make a 2006 Roth contribution if your 2006 income was over $110,000 if you file a single return, or over $160,000 on a joint return. The trick is that savvy investors know that the earlier in the year they stash their cash in an IRA, the sooner the earnings are tax free. But you're not certain about your income until the end of the year.

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That's the pickle these viewers find themselves in.

There are a couple of ways to solve the problem. You can simply ask your IRA sponsor to give you your money back. As long as it's out of the account before you file your 2006 tax return, you'll avoid the 6% "excess contribution" penalty. Now, the sponsor also has to figure how much the contribution has earned so far and send that money to you, too. You have to report and pay tax on the earnings on your 2006 return ... and you'll owe a 10% penalty if you're under age 59#189;.

The other solution is to have the IRA sponsor move your Roth contribution -- and its earnings -- to a traditional IRA. Do this by April 17 and the law treats it as though the money went to the traditional IRA in the first place. There's no income limit for contributing to a regular IRA but, if you also have a retirement plan at work, you won't be allowed to deduct your deposit.

See Kevin's previous tip.