Help! I made a Roth IRA mistake (Soledad Says #5)

Dear Single Mama,

I'm so honored that you reached out to me to try to get some support. Filing our taxes can be a stressful time especially when we are dealing with forms we have never had to file before. So let me start by explaining these forms.

Form 5498 reports IRA contributions (among other things) to the IRS. Your brokerage firm is probably the one who mailed you a copy of this form along with the IRS. You don't have to file this form with your taxes. Just keep it for your records. It looks like the form below.

Anyone who receives a distribution of $10 or more from an IRA (among other types of accounts) can expect to receive a 1099-R. Now this may be confusing since you can withdraw contributions you make to your Roth IRA anytime, tax- and penalty-free. This means if you contribute $100 to your Roth IRA, you could pull out $100.

However, if you withdraw earnings from your Roth IRA you can expect to pay taxes and a penalty. So if you contributed $100 and due to the index funds you purchased, it grew to $501.31 and then you pulled out $150 you will need to pay taxes and a penalty fee on the $50.

This 1099-R form reports how much you withdrew, how much of the distribution was taxable and how much. How much you will have to pay in taxes is a combination of the taxable amount seen in Box 2a and whether you have to pay short-term capital gains taxes or long-term capital gain taxes.

Worse case scenario you have to pay short-term capital gain taxes because you held the investments for less than a year. The most you will have to pay is 12% since you will be taxed at the same rate as your ordinary income tax bracket. However, I'm unsure what your marginalized tax bracket is since you are collecting "non-earned" income. (If you ask me, any income a Veteran receives should count as earned income but unfortunately laws don't agree with me right now.)

Now there is a penalty for contributing to a Roth IRA when you are not legally allowed to do so because you don't have enough earned income. These are called "excess contributions" and are taxed at 6% each year in when they remain in your IRA. You will most likely have to file Form 5329​

In most cases, the best way to deal with an excess contribution is to withdraw the excess amount as soon as possible. You can avoid the 6% penalty by doing this if you withdraw the money you contributed to your Roth IRA before you file your tax return for the taxable year of the contribution. So if you contributed to your Roth IRA in 2021, then make sure to withdraw the amount before April 18, 2022 when taxes are due for 2021.

I hope this newsletter gave you a better understanding of the forms you received and what you need to do moving forward to remedy contributing too much to your Roth IRA.

However, I hope it continues to just be the beginning of your financial planning. Military OneSource offers FREE and personalized financial counseling to all active-duty service members, National Guard, reserve members and their families and survivors. They could possible review all your finances and help you determine what accounts you should use to invest moving forward.

As a veteran, you may not qualify for their services BUT they are affiliated with the U.S. Department of Defense and they can probably direct you to trusted sources for veterans.

I also want to encourage you to use this IRS search tool to find FREE tax prep help. You do not have to figure this out alone. There are more people like me who want to help con cariño out there.

Keep me posted on how this all turns out for you. If you have any questions, feel free to send me another message. The more of us talking dinero, the better!

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Todo con tiempo,

P.S. I'm hosting a FREE Roth IRA workshop on February 22, 2022 at 4:30pm PST/ 7:30pm EST. If you are available to attend live, you can register here.