Exceeding the Roth Income Limit

I made my 2007 contribution to my Roth IRA last July. But I just discovered that my year-end bonus put me over the income limit to contribute to a Roth ($114,000 in 2007 for single filers, like I am). What should I do? Is there any way to avoid the penalty?

Fortunately, there is because you caught the mistake before your 2007 taxes were due. You can avoid the 6% excess contribution penalty by withdrawing your 2007 contribution -- plus all the earnings on that money -- by the due date of your 2007 return plus extensions (which push the deadline back to October 15, 2008).

You still need to report the earnings as a taxable distribution on Form 1040. You'll owe tax on that amount in your top bracket, plus a 10% early-withdrawal penalty if you're younger than 59½.

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But there is a way for you to avoid that penalty and the tax bill, too. Contact your IRA administrator and switch your 2007 Roth contribution, plus any earnings on that money, into a traditional IRA before October 15, 2008 (your IRA administrator should be able to help you calculate your earnings on a pro rata basis).

Most IRA administrators have a form that makes it easy to "recharacterize" your IRA (the official term for switching from one type of IRA to another). If you're switching the Roth into a nondeductible IRA, you'll also need to file IRS Form 8606 to report the nondeductible contributions.

You need to recharacterize only your 2007 contributions plus the earnings on that money. You don't have to touch the remainder of your Roth account.

For more information about Roth and traditional IRAs, see Everything You Need to Know About IRAs. Also see IRS Publication 590 Individual Retirement Arrangements.

As the "Ask Kim" columnist for Kiplinger's Personal Finance, Lankford receives hundreds of personal finance questions from readers every month. She is the author of Rescue Your Financial Life (McGraw-Hill, 2003), The Insurance Maze: How You Can Save Money on Insurance -- and Still Get the Coverage You Need (Kaplan, 2006), Kiplinger's Ask Kim for Money Smart Solutions (Kaplan, 2007) and The Kiplinger/BBB Personal Finance Guide for Military Families. She is frequently featured as a financial expert on television and radio, including NBC's Today Show, CNN, CNBC and National Public Radio.