My wife and I both contributed $4,000 to our 2006 Roth IRAs in January 2006. I finished working on my taxes this weekend and discovered that we went over the $160,000 adjusted gross income limit to contribute to a Roth. What can we do to avoid a penalty?

You could avoid the 6% excess contribution penalty by withdrawing the 2006 Roth contributions, and all of the earnings on them, by April 17, 2007. You would report the income earned on it as a taxable distribution from the IRA on line 15 of your 2006 Form 1040 and pay tax on that amount in your top tax bracket. If you're under age 59½, you'd also have to pay a 10% early withdrawal penalty on the income distribution.

But you can avoid all of the penalties if you contact your IRA administrator right away and explain that you just discovered your 2006 income was over the limit. You won't be hit with a penalty as long as you have the administrator switch your 2006 Roth IRA contributions -- and the earnings on them -- into a traditional IRA by October 15, 2007. If you'd already made contributions to the Roth in earlier years, the administrator should calculate how much of the earnings in the account should be attributed to the 2006 contribution.

Most IRA administrators have a form making it easy to "recharacterize" the IRA, which is the official term for switching from one type of IRA to another. If you don't already have a traditional IRA account with that administrator, you'll need to open one up.

If you're switching the Roth into a nondeductible IRA, you'll need to file Form 8606 to the IRS reporting the nondeductible IRA contributions. For more information, see the Instructions to Form 8606.

You only need to recharacterize your 2006 contributions (and the earnings on those contributions). You can keep any money you've contributed to the Roth in previous years in your Roth account.

The money you switch to a traditional IRA now doesn't have to stay there forever. Generally, you can convert a traditional IRA to a Roth only in years when your income is below $100,000. But that income limit disappears in 2010, letting anyone make the switch. You just need to pay taxes on the earnings (or on the full amount of any tax-deductible contribution) when you convert the traditional IRA to a Roth, but then you won't owe taxes on it when you withdraw the money from the Roth in retirement.

MORE: Kiplinger.com | Your Money | Taxes | Column

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