Retirement Withdrawal Strategies & Excess Roth IRA Contributions

Retirees and pre-retirees often struggle when it comes to spending down their nest egg in retirement because of the fear of the unknown. No one wants to run out of money too early. Yet most people would also like to enjoy what they've worked so hard for. So, how do you find that balance? How do you know what you can spend and for how long? Living off of your wealth is entirely different than building your wealth. And without a retirement spending strategy, most people are going to either end up really worried about running out of money too early throughout their retirement but end up leaving a pile of money on the table when they die or running out of money too early in retirement, which for some can be scarier than death itself.

Welcome to the Retired-ish podcast, where we discuss all things retirement planning, taxes, financial planning, investing, estate planning, Medicare, Social Security, lifestyle, you name it, I've got you covered. I'm your host, Cameron Valadez, certified financial planner and enrolled agent.

Today we are going to discuss retirement income planning or strategies, I should say. We also have an awesome listener question I read recently, which I think will help so many of you listening, so stay tuned.

First, I want to talk about why retirement income planning is so important. Traditionally in life, we start by identifying money that we can put away and save that won't impact our current lifestyle. Then, we start investing that money once we identify the power of time and compounding or compound interest. And then we enter sort of an automated phase of our life where we continue to invest and grow our assets. And it's kind of on autopilot.

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And we do this for decades as we work and earn a paycheck. Now, most people will work 30 plus years, and so they have 30 years or so of deep-rooted experience in saving and investing and making these sacrifices. And eventually you make it to kind of the finish line or the next chapter where now you have to enjoy retirement and enjoy some of the fruits of your labor and the sacrifices you made along the way. But this next chapter brings forth the real challenge, which is when you have to flip the switch and begin to spend down your assets versus continue to accumulate them. In other words, you need to replace that paycheck, right? The issue is you've been putting money away for 30 years or so, and you've got this momentum or inertia. You're so used to saving and still having a paycheck at the same time, and now, all of a sudden, you hit a wall, and you need to learn how to spend it. After all, that's why you originally started saving it.

But for most pre-retirees and retirees, this is a struggle because of the fear of the unknown. No one wants to run out of money too early. Yet most people would also like to enjoy what they've worked so hard for. So how do you find that balance? How can you know what you can spend and for how long? That’s the essence of what we're talking about today.

Withdrawing income from a savings nest egg is sort of an art and a science, whether it be a retirement account, multiple retirement accounts, personal investments, trust accounts, money you inherited, or some combination thereof. Within the retirement planning arena, there are various retirement income strategies and different versions of each of those strategies. However, they can essentially be condensed into three fundamental categories, in my opinion, which are one, a systematic withdrawal plan, which is fairly basic and static in nature, meaning it doesn't really change much over time. Secondly, we have time-based segmentation or some version of what many may refer to as a bucketing strategy.

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Third is what I call the floor and upside strategy. And lastly, a dynamic spending strategy which can be a combination or variation of the other strategies, but this one is dynamic in that it can change over time. I will go through some common versions of each of these in a moment, but first, I want you to know that you may choose to use one of these strategies or a combination of all three. Your goal when picking a retirement income strategy, whether you are in or nearing retirement, is to avoid having to make any significant changes to your retirement plans or your lifestyle, regardless of what the economy or the stock market, let's say, is doing at any given time. It is important to remember that no specific financial product or strategy is the single best choice for all retirees.

There are no black-and-white answers in financial planning or retirement planning. You or you and your professional advisor will need to plan for your transition into retirement, discussing the new risks that you may face as a retiree, and structure a strategy to produce the income you will require throughout the remainder of your retirement. The retirement income strategies you choose to implement, whether you use a systematic withdrawal plan, a dynamic spending strategy, a bucket strategy, or some other method, must be based on your specific lifestyle goals and your ideologies around money.

So, what do I mean by that? Well, when it comes to doing any form of financial planning, you should always start with identifying goals, not just specific, quantifiable goals related to experiences like, hey, I want to be able to travel overseas for the next five years of retirement or the first five years of my retirement with a $20,000 per year travel budget, for example.

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Now, you will definitely want to set specific goals like that, but you will also want to incorporate your relationship or ideology about the money you worked your butt off to save. For example, do you want to leave money behind when you die to a spouse or children? Maybe a charity? Or do you want to enjoy as much of it as you can and die with hypothetically $0 while also trying to make sure you don't accidentally run out of retirement income or money too early? These are the things you want to ask yourself before building a retirement income plan or a withdrawal strategy. Without a strategy, most people are going to either one, end up really worried about running out of money too early throughout their retirement, but then actually end up leaving a pile of money on the table when they die. Or they actually do run out of money too early in retirement, which, for many is scarier than death itself. So doing something is going to be much better than doing nothing, not only for your money but for your mental well-being.

There are a lot of ways to create a withdrawal or spending strategy. There are different methods, there is a lot of academic research and much left to be done, and each method out there can actually and should be slightly customized depending on what your needs and preferences are. Many of these methods I'm going to discuss require careful monitoring and adjusting over time. Or in other words, they will be dynamic, and some will be rather static. As much as we'd like to automate our retirement income by having a basic and static strategy, implementing any strategy over a long period of time, such as a 30-year retirement, will likely require adjustments and be dynamic because, as we all know, life changes and plans change.

The ultimate purpose of these strategies is to give you the confidence and the permission to spend a particular amount of money from the assets you've accumulated in order to meet those goals that you have. For example, a lot of times, what I find when building out a retirement income strategy for a client who is preparing for a nearing retirement is that we may discover that they can actually retire sooner than expected. Other times, some think they're ready to retire, and when we map everything out for them, they realize they actually won't have enough for their dream lifestyle and maybe need to adjust.

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As you can see, either way, doing this planning is extremely useful and important to give you an expectation. Now, before I get into the strategies themselves, I want to make one more comment. When choosing a strategy, you will also need to have an idea of what your spending pattern and behaviors might be like throughout retirement. For instance, some people have just always been very frugal and don't spend a lot and probably never will. Some people want to go all out and enjoy as much as they can as early as they can and spend big early on. Some people want to keep spending even keel, and usually, these are the people who already have a good work-life balance before completely stopping taking a paycheck. And others, and you know who you are, spend tons of money all the time and have packages showing up at the door every day.

There's not necessarily anything wrong with that, but you need to be honest with yourself and identify how you will be spending money moving forward. This is one of those factors that may change significantly over time and require changes to your income plan, but it's important to factor in at first because this will help you determine the type of strategy you want to use and how you're going to use it. This can give you an expectation, as I said, for what you can spend in retirement while striving to meet your desired goals with the highest probability of success.

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There are pros and cons to each of these strategies. Depending on the dollars you have accumulated and the amounts that you want to spend, a static withdrawal may result in running out of money too early or leaving a ton of money on the table, while a dynamic strategy changes over time in order to try and get you as close as possible to leaving either a specified amount of money behind for errors or getting as close to dying with zero. But you might have to slightly adjust your spending up or down at one or multiple points throughout your retirement. These dynamic strategies can work very well, but they require a lot more planning efforts and monitoring than a static strategy, and they might be harder to stick with if you're implementing it alone. So, my goal is to give you a general overview of some of the different types of retirement income strategies that I mentioned earlier. Now, I'm not going to dive too deep into some of the intricate details of some of them because they can get quite complicated. But again, I want to give you a general overview. First, I want to start with the more basic strategies known as the static strategies and the strengths and weaknesses of each.

The first I want to mention is the systematic withdrawal plan, sometimes called a constant dollar plan, which is probably the most well known. Now, one very popular version of this is actually called the 4% rule, and that came into existence in the nineties, which assumes, based on old academic research, that you have a pretty good chance of being able to withdraw 4% of your total investment balance over around a 25-year retirement span with cost of living adjustments without running out too early. For example, if you have, say, a $1 million portfolio at the start of retirement, 4% would give you $40,000 a year. The goal is essentially to draw down wealth from a volatile portfolio, although diversified portfolio. In addition, using this strategy, you will always maintain control of your investment capital. Now, the strength of this strategy is that it ensures that your quality of life stays consistent as it adjusts annual withdrawals for inflation. And remember, you're taking that same amount each year. So again, your income is fairly consistent.

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This strategy can also have a reasonably high rate of success, but this relies heavily on your portfolio's asset allocation, meaning how you're invested what you're investing in, how diversified you are, and the actual length of your retirement can have an effect on this strategy as well, and the initial withdrawal percent. So again, in my example, I gave you the 4% rule, but that doesn't necessarily mean you have to do 4%. You can pick whatever you want, depending on your goals. One of the weaknesses of this static strategy is that if the portfolio isn't large enough, it may not provide you with enough cash to support your desired lifestyle and goals at a withdrawal rate of, say, 4%. This might tempt you to withdraw more and deplete the portfolio faster. Another weakness is that it doesn't account for one-off large and unexpected portfolio withdrawals, which everyone will have at some point, in my experience, throughout their retirement. Another one is that if you have an unlucky sequence of returns, it might not work out so well if you're unsure what that is. We've actually discussed the sequence of returns in previous episodes, so if you missed that one, I will provide a link for it in the episode description and the show notes.

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And if you have an unlucky sequence of returns, this can deplete even a very large investment portfolio if you get poor returns in the market or with your investments at the onset of retirement.

And lastly, spending is not reduced when the economy or the markets are doing poorly. This increases the likelihood of running out of money too early compared to some of the other strategies we're going to go over. Also, I'd add that spending is not increased when the economy or market is doing well other than your inflation adjustments. So, you can sometimes end your retirement with a considerable amount of money, meaning you're leaving a lot of money on the table, which, again, might not be part of your plan. There are definitely more nuances to a strategy like this, and the 4% rule is just one example. The bottom line is that the larger your portfolio is relative to your expenses, and the stronger your net worth, the more appropriate this strategy becomes. The more you have saved and invested in your ability to control your expenses, the less risk you will incur taking the small annual withdrawals needed to support your lifestyle, and the more risk you might be able to take with your portfolio's investments and unknown future investment returns.

The next type of strategy would be a time-segmented approach. As I mentioned, some call this a bucketing strategy. This type of strategy is useful because, for many retirees, it is easier to understand and stick with over the long run, which, in my opinion, is one of the number one factors in choosing a retirement income plan. In fact, my firm, Planable Wealth, actually prefers using a version of this in combination with a dynamic spending strategy. Although it is highly customized per individual. The time-based segmentation or bucket approach segments retirement assets by specific categories. Categories may be based on the risk level of the assets in the investment portfolio, the needs or expenses these assets are expected to cover, or the time in retirement when the assets are expected to generate income.

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The time-based segmentation calls for creating a specific income stream at the front end of retirement to meet upcoming lifestyle spending goals, with growth pursued through more volatile equity investments held in the remainder of the portfolio. For example, you may have three segments or buckets: one for upcoming large expenses and your required annual income for maybe the first three years of retirement, let's say, and another bucket for your income needs in years four through five in retirement, and then the last bucket or the third bucket for your income needs. Anything past five years.

Typically, early segments or buckets have an allocation to very low, volatile investments that are either not subject to fluctuation of principal or have very little fluctuation. Later segments, or buckets, because they contain the money earmarked for future goals, such as a future income need, are typically allocated to higher volatile investments to allow for greater potential growth in order to outpace things like inflation and overcome tax issues. This time segmentation can help you weather the short-term volatility of your investments because you realize that these segments, most subject to volatility, will not need to provide income for many years, which can help mitigate that sequence of returns risk. It can also help with investment behavior, and it can help you avoid making costly investing mistakes when markets or the economy experience drastic downturns. A time-based allocated structure also provides a yardstick for measuring how well the different buckets perform and adjust. You or your advisor can calculate the target Amount each bucket needs to generate to produce a desired income.

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You can then measure the strategy's progress every year to determine if, let's call it, harvesting, is appropriate, or in other words, the refilling of a particular bucket. It forces you to think in terms of specific cash flow needs when you expect to have these needs and the investment strategies required to satisfy them. Some of the strengths of this strategy are that, again, it's easy to understand and stick with throughout retirement. It can help mitigate sequence of returns risk, and it has the ability to account for additional large, expected, and even unexpected withdrawals.

Now, some of the main weaknesses are that it can be difficult to construct the investment allocation in the portfolio for the various buckets and your different goals in order to preserve your income needs over a 20 to 30-year retirement. Secondly, it requires ongoing maintenance to refill and rebalance the various buckets or time segments over your retirement. And lastly, it can add longevity risk in low interest rate environments at the start of retirement, meaning if interest rates are too low and in your immediate need buckets or, let's say, bucket one, in my example, if interest rates are too low, that money might not be able to keep up with some of your spending or inflation.

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Moving along, we have the floor and upside strategy now. With this strategy, before investing in any type of investment portfolio, the first step is to determine a floor or safe cash flow stream for your retirement years. To do this, you must define your baseline income need for retirement, either on a monthly or annual basis, and factor in any other guaranteed income sources you might expect, such as Social Security or possibly a pension, for example. It is vital that prior to retirement, you identify your essential annual retirement expenses or those fixed expenses and bills that must be paid. Then, you need to determine your discretionary expenses or fun money and your goals throughout retirement, including any money you might want to leave behind for heirs. You essentially would need to do this with any strategy you choose, but for this one it's absolutely necessary so you can determine the floor. The strategy then uses a combination of pension, Social Security, and risk-free income from your other investments to cover those essential expenses and possibly some discretionary expenses. Again, this is your income floor, which is the base amount that you must have to sustain your lifestyle.

Whatever you may have above the floor goes into an upside investment portfolio, and this is for different wants, wishes, needs, and money for heirs, possibly. Because the income floor should be risk-free, your retirement income plan is secure. Your remaining upside portfolio can resemble a more conventional investment portfolio with a balance of maybe stocks, bonds, cash. You name it. As similar to the systematic withdrawal strategy or the medium and long-term buckets of the bucket strategy, you might even place rental property income in this area.

Now, depending on the strength of your savings, your upside portfolio may have a more or less cushion above the floor. So you can afford more or less exposure to market or economic volatility. The bigger the cushion, the more volatility in your investments you can afford. The critical difference between the income floor upside strategy and the other two strategies is the risk-free income floor. The other two approaches do not set up a risk-free income floor that will last if you were to live well beyond average life expectancies.

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Instead, they project a probability that a certain withdrawal rate will not exhaust your portfolio too early, with some slight percentage possibility that it will. The floor and upside strategy does not leave this to chance, sometimes referred to as a safety-first philosophy, as opposed to maybe a probability-based philosophy. The kind of risk-free floor you will need to secure your retirement depends on how much you have saved and whether you are underfunded constrained, meaning things are okay or very well funded for your future income needs. If you are underfunded, you can't afford to expose your savings to significant market volatility. Even a small market loss will only make your retirement situation less tenable.

Instead, if you have limited savings, you should look to trim expenses, consider working longer, or possibly consider purchasing insured income via some sort of annuity from an insurance company. These can provide the maximum safe and effective income rates available, higher than any systematic withdrawal rate that might be considered safe. If you go this route, you can maximize the annuity benefit even further by spending other cash-like assets earlier on in retirement, such as treasury bills, and deferring the annuity payments so that the guaranteed income benefits can increase further before taking them.

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And I have talked about the potential use for annuities and deferred annuities in order to provide income in a previous episode. So, if you're unfamiliar with what I'm talking about there, be sure to check that out. I will add a link to that in the episode show notes for today.

If, on the other hand, you had a good savings habit during your working years and find that you are well funded, you have more options, both for your income floor and for an upside investment portfolio for other discretionary goals and expenditures. If your upside portfolio is large enough, your secure income floor can essentially be a systematic withdrawal, like we talked about before, from your upside portfolio, with your income floor being some percentage of the full portfolio earmarked for retirement income spending. However, in that case, since the floor would not be secured with something like an annuity, for example, you would need to monitor the portfolio carefully and move at least the amount earmarked for the floor into cash or some other secure flooring as the markets begin to turn down, or preferably since we don't want to try, and time markets already have that set aside just in case. This can be risky, especially if your portfolio lacks a sizable cushion.

Okay, so what are some of the strengths of a strategy like this? Well, the main one is that you won't have much risk of running out of money too early compared to some of the other strategies. At least when it comes to your floor income amount. You will have a more predictable income for life without much variation, and it's easy to understand and can be easier to implement over time, with most of the monitoring having to do with the upside portfolio, not so much with the income floor.

Now, the weaknesses are that you could be in a low interest rate environment and so the income floor can get expensive, meaning you need to save more and spend less while still working to make your future income floor stretch 30 or so years. If you desire cost of living adjustments, you will likely need to use money from your upside portfolio to supplement that, and this might be hard to effectively manage over time. Another weakness is that you will likely need to have a bigger nest egg than some of the other strategies since you have the potential for more growth in some of the other strategies.

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And lastly, if you do choose to use insurance products such as annuities, the cost of implementing could be higher than others since you will be paying for guarantees from an insurance product.

To summarize, the income floor upside strategy uses the strength of your savings relative to your essential and discretionary annual expenses to build a risk-free income floor that will last as long as you live. The income floor is built from a combination of cash or short-term bonds, maybe immediate and or deferred income annuities, or preferably laddered government bonds that match your current and future expenses. Only once this floor is secured, any additional funding is exposed to volatility in an upside portfolio designed for more long-term growth and discretionary goals.

Okay, let's move on to the last type of strategy I want to discuss, which is the dynamic spending strategy. Now, for the sake of this episode, I am only going to go over one version of this strategy, and there are many. This one, a lot of people refer to it as an income guardrail strategy, and I'll get more into that in a minute. However, a dynamic spending strategy, in general, is one where you set some sort of parameters to help you dictate what to spend while reducing the chances of running out of money too early, although none of these are completely bulletproof. And some versions, such as the traditional guardrail approach, can also be used to mitigate the risk of leaving a ton of money on the table if you end up living a full 25 to 30-year retirement.

What makes the guardrail approach different from others is because of what is called the three decision rules. These rules adjust how much you withdraw each year based on how the market or your investments are performing and how much money remains in your portfolio at any given time.

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One of the rules determines whether or not you should adjust your withdrawal rate for inflation in any given year. The other two rules increase or decrease your withdrawal based on the health of your portfolio. These rules state that if the rate at which you are withdrawing from your assets adjusts upward or downward significantly, it's time to adjust your income up or down, and this can happen if the value of your portfolio moves substantially.

Now, I know that might have sounded a little confusing, but bear with me for some clarity. I'm going to give you an example.

Let's say you have a $1 million portfolio, and you take $40,000 a year to supplement your income. That is a 4% withdrawal rate. If your portfolio drops to 800,000 and you still take that same $40,000 a year, now you essentially have a 5% withdrawal rate. And at that time, because that withdrawal rate moved from four to five, the rule for your particular strategy may suggest that you adjust your income downward to help alleviate that pressure.

And on the flip side, if, say, your $1 million grew to $1.2 million, and you're taking that same $40,000 a year, your withdrawal rate is now 3%. And because that adjusted from four to three, the rule in your strategy may suggest that you increase your income to help make sure you don't leave too much money on the table. The upward adjustments help make sure that you spend more again so that you don't leave too much money on the table, and the downward adjustments help mitigate the risk of running out of money too early. I will note, however, that there are more finite rules to follow when operating a strategy like this, and your strategy might be a different variation of this. And the actual adjustments to your income, like I gave in that example, aren't extremely frequent or common. For instance, you're not likely to have a certain withdrawal amount for, say, three months then have to change it in another three months, so your income is fluctuating all over the place. This adjustment usually happens when there are substantial changes to your investment balance, which do happen and will happen over the length of your retirement, but just not as frequently as you might think.

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Plus, the adjustments aren't too substantial. Understanding your guardrails also allows you to have an expectation of when you may start to spend more or less, which can help with planning because you will be able to keep an eye on your investment balances over time. And if you know what those different guardrails are, you'll know, hey, I might have an adjustment coming up to tighten the belt and reduce my income. Or hey, it looks like in the near future, I might have the ability to increase my income. So you get that expectation. Now, some professionals who specialize heavily in retirement planning may even take this strategy to another level and base these increases or decreases in income on changes in the probability of success using very specialized software. This is what is known as a risk-based guardrails approach. Now, because of the different decision rules and ongoing adjustments, this is one of the most complicated withdrawal strategies. But it can be very useful.

So, let's go over some of the major strengths and weaknesses of this type of dynamic spending strategy. One of the strengths is that it responds to market or investment conditions and, therefore, increases the rate of success by reducing spending when the market is performing poorly and increasing spending when the market does well. It responds smoothly to market conditions so that occasional changes to your withdrawal are small. Unlike some of the systematic withdrawal strategies that you might employ, it has a low likelihood of exhausting a properly diversified portfolio, even over long retirement periods. It also has a mechanism for providing cost of living adjustments over time to help keep pace with inflation.

All right, so what are the weaknesses? Well, like all withdrawal strategies that vary based on market conditions, annual withdrawals can become too low for your lifestyle without any minimum withdrawal in place or a floor. Another weakness is that the three decision rules make calculating your annual withdrawals quite complex and cumbersome over a potential 20 to 30-year retirement when you're trying to do this on your own.

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At first, it might be rather simple, but you're going to have to monitor and track that and make those adjustments when necessary. All in all, retirement income planning is a vast and complex arena. There are, of course, variations of each of the different types of main withdrawal strategies I discussed and plenty more that I didn't discuss. Many of them have differing amounts of academic research that back them, and each has its own benefits and drawbacks. Some strategies can be designed to maximize your spending and aim to leave little to nothing at the end of a 25 to 30-year retirement, while others will purposely aim to leave a certain amount of money on the table for a spouse or heirs, the one that's best for you will always depend on your situation and your desired lifestyle in retirement. I would suggest that whatever you choose to implement, you make sure it aligns with your ideology around money. I find that this doesn't get talked about enough or get much consideration in the real world, but it should. I have yet to meet anyone who didn't want to enjoy retirement to the fullest and not consistently worry about having enough money.

That does it for today's topic, but we are not done yet. I want to pivot over to one of our listener questions that came in. This has nothing to do with retirement income strategies, but it does have to do with a very common problem you may eventually face or maybe already have faced as a retirement saver. This week's question has to do with excess IRA contributions. All right, so let's get to it. Our fellow listener asks hi, Cameron. Quick question for you. I made an excess contribution to a Roth IRA in 2023. I didn't realize my mistake until after submitting my 2023 tax return.

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I have since had the excess contribution removed along with the total applicable earnings. My question is since I will not receive a 1099R, which, for those of you who might not know, is just a tax form, until next January, when am I required to report this income to the IRS and pay taxes on it to avoid a penalty? Everything I see on the Internet says it must be done by October 2024 via a 1040X. And again, for those of you who might not know, that is simply an amended personal income tax return. What is your understanding of this deadline? Thanks in advance for your help.

Phew. Okay, this is going to be a long-winded answer since I think it will help everyone to have a better understanding of all this since it is so common. It's an absolutely great question. It's a little technical but great because, like I said, this happens all the time, and most people get a little stumped by the circumstances. So, let's break it down and explain what she's even talking about. Excess IRA contributions are contributions that exceed the limit that someone can contribute to their IRA or Roth IRA for any given year. There is an annual max each year that you can contribute to these accounts.

Let me give you some examples of different types of excess IRA contributions that someone might make. The first and most basic that I mentioned was contributions that exceed the maximum annual contribution limit for the year. For example, it's $6,500 for someone under age 50 in 2023 or $7,500 for someone over age 50 in 2023. Another is that you might make an IRA contribution of any dollar amount when you don't have any earned income during the year.

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What that means is in order to contribute to one of these accounts, you have to have what is called earned income, which means income from something like a W2 job or maybe being self-employed. Another way someone might make an excess contribution is if they make a Roth contribution when they are over the income threshold. So, if you make over a certain amount of money, you cannot contribute to a Roth in the traditional fashion. This happens frequently when someone has Roth IRA contributions, maybe on a monthly basis, automatically being deposited into their account, and all of a sudden, they have a year where their income is over the threshold or way over the threshold. Then, they become ineligible to contribute to that Roth via the regular methods. Another common one is if you roll over an amount that isn't actually eligible for a rollover. So yes, even though you might deem something a rollover or think it is a rollover, it can be classified as a contribution. It's kind of tricky, and that's why you got to know the rules.

Some examples here are things like trying to roll over a required minimum distribution, also called an RMD. Or you do a 60-day rollover that's completed after the 60-day clock expired, or do a Roth conversion before an RMD is paid out from the IRA that you converted from. So, as you can see, there are quite a few situations where this excess contribution issue can crop up.

So here's the big problem. If a taxpayer contributes more than they are allowed to in any given year to an IRA or a Roth IRA, in other words, they make an excess contribution. A 6% penalty will be issued on the excess contribution and its earnings each year until the excess contribution and its associated earnings are withdrawn from the account. And by the way, this penalty is not limited to just the one year in which the excess contribution is made. It's 6% each year until it is removed.

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Now, fixing the excess amount isn't as easy as simply removing the amount you over-contributed or the excess back out of the account. The only way to fix an excess contribution is to withdraw the excess plus or minus any potential earnings or interest that money has made by October 15 of the year after the year for which the contribution was made. The earnings or interest that your excess contribution might earn in the account that I just referenced is what the IRS calls the net income attributable or NIA.

For example, if you contribute $6,500 but you have no earned income for the year, oopsie! You weren't allowed to do that, but also double oopsie because my 6500 was invested after I put it in, and it earned $200. Now that $200 is that NIA. I mean, it's not really that big of an oopsie since you made money in that example, but it can be a pain to fix. So it sounds like, in your situation, the investment custodian where you have your account may have calculated that NIA for you since you say it was already removed. I'm not sure.

Sometimes, the NIA can be quite cumbersome to figure out, especially if you have things like dividends reinvesting or have been making years' worth of excess contributions. In that case, things can get really messy. By the way, if any of you ever run into a situation like that, I would strongly advise reaching out to a financial planner to help you get that sorted out. And our firm, Planable Wealth, has helped countless people with this issue. Okay, so now let's talk timing. In this case, you've made an excess IRA contribution for the year 2023. You didn't state the amount though, so I'm guessing maybe all of it.

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But you withdrew it in 2024. You pulled it back out along with the NIA, the interest you might have earned once you realized you oopsied. The good news is that you are well within the timeframe, and you are correct that you will have until October 15 of 2024, to fix it and avoid the 6% excess contribution penalty. When an excess contribution, along with the NIA, is timely withdrawn. So, by that October 15 deadline, the excess itself is not taxable or subject to a penalty. So there is no 6% contribution penalty, excess contribution penalty, or even a 10% early distribution penalty if you were to be under 59 and a half. However, the NIA, the interest that that contribution made is taxable for the year of the excess contribution, not the year of the distribution or when you pulled it back out.

And this is the key I want you to focus in on because the year of the distribution for you sounds like 2024 since that's when you pulled the money out of. But, the excess contribution was made for 2023. So the NIA would be taxable in 2023, meaning, unfortunately, it's gonna go on that 2023 return. And so, yes, it looks like you're going to be considering an amended tax return, which is that 1040X that you referenced.

Now, one cool tidbit is that as of the recent passing of the Secure Act 2.0, the NIA is no longer subject to a 10% early withdrawal penalty if you happen to be under age 59 and a half when pulling that back out. So there's a small win there for some people. Another extremely important change that came from the Secure Act 2.0 states that there is now a six-year statute of limitations for the 6% excess contribution penalty. However, prior to the Secure Act 2.0, the IRS could go back for an unlimited amount of time to assess this penalty unless the proper IRS form 5329 was filed to correct it. If that form was filed, that statute of limitations actually began at that time. So, in other words, if someone had an excess contribution they made 15 years ago and they didn't fix it and file the appropriate form, the IRS to this day can go back and assess the 6% over all of those years.

[00:43:56]:
Not good. Moving forward, though, because of the Secure Act 2.0, you will have six years to pull that money back out, whether or not you file form 5329. And a recent court case tells us that the new six year statute is not going to be retroactive to any excess contributions before the Secure Act 2.0 was implemented. So, in this case, you only get that six year statute of limitations if you made these excess contributions after Secure Act 2.0 was implemented. Although this isn't the case in your particular question, if you are removing an excess contribution after the required deadline, then the excess contributions must be reported to the IRS on that form 5329, part three, where it says additional tax on excess contributions to traditional IRAs, or part four, additional tax on excess contributions to Roth IRAs. This form can be filed with your tax return or by itself. We will tackle more on excess contributions in a future episode, but hopefully, this answers your question and much more. I know the answer was lame.

Amending returns is no fun. Excess contributions are. They aren't fun. They're a pain in the butt to fix. Now, I'm not saying there aren't any other options for you as far as funding your Roth. So, if that's a major goal of yours, you might want to get connected with an advisor who can assist you there and help you do some strategizing. For example, I don't have the exact details of why there was an excess contribution in your particular situation.

Like I said, I gave a lot of examples of how that might happen. Like if it was just that you contributed a little too much because of your earned income, but you were under the max, or maybe you had no earned income at all and you maxed it out on accident. But just so everyone's aware, if you make an excess contribution in one year but then are eligible to contribute in the following year, you might consider carrying your previous year's contribution that excess amount forward to apply towards the current year's contribution and that can normally be done by your investment custodian where you hold your account and you might be able to avoid a lot of this mess. Unfortunately though, in this situation, it sounds like the money was already pulled out.

Hopefully, this was helpful. If you find the information and strategies I provide on this show actionable and insightful, please do yourself a favor and subscribe to or follow the show on your podcast app and share with a friend who you think might benefit. And don't forget to sign up for the Retired-ish newsletter to get useful and easy-to-digest information on retirement planning, investments, and taxes once a month, straight to your inbox. No spam. Although some of the stuff I talk about on the show might be a little complicated in the newsletter, we provide very easy-to-read charts and explanations, and we put things in layman's terms to just further your education on these topics and help you understand them a little bit better.

[00:47:01]:
Of course, if you want to learn more about the topics I went over in the show today or you want to connect with us to see if we can design a retirement income plan or give you a second opinion on your current retirement withdrawal plan and help you work toward reaching your goals, you can find the links to the resources we have provided in the show notes right there on your podcast app, or you can visit us at retiredishpodcast.com/49. Thanks again for tuning in and following along. See you next time on Retired-ish.

[00:47:54]:
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