So you contributed too much to your Roth IRA.
This is often caught during tax season or when reviewing our client’s previous year tax returns.
There are several reasons that cause you to contribute too much to your Roth IRA, but the most common are:
- Contributed more than the annual amount allowed ($6,000/per person under the age of 50; $7,000 for those aged 50 and above)
- Contributed more than their earned income
- Or, most commonly, their income was too high to contribute to a Roth IRA based on IRS Limits
4 Steps to Fixing an Excess Roth IRA Contribution
Upon preparing your tax return, should you find that you contributed too much to your Roth IRA, there are 4 primary ways to remedy:
1. Remove the excess contribution prior to the tax filing deadline (including extensions):
In a best-case scenario, if you discover the excess Roth IRA contribution prior to filing your tax return, you can withdraw the funds. If the funds within the IRA have appreciated since the original contribution, you’ll need to withdraw both the excess contribution and the prorated portion of the appreciation earned from the date the funds were contributed, to the date they are withdrawn.
While you will not owe tax on the withdrawal of the over contribution itself, you will owe tax on any appreciation earned at your marginal tax rate. Additionally, if you’re younger than 59.5 you will owe a 10% penalty on the gain. Note, if you’ve already filed your return but the filing deadline (including extension) has not yet passed, you can file an amended return. The deadline plus extensions is typically October 15th.
2. Recharacterize the contribution:
If not withdrawing the excess contribution, you can choose to recharacterize the contribution from a Roth IRA to a Traditional IRA. Assuming you meet the requirements to contribute to a Traditional IRA. Alternatively, if your income is too high to deduct the contribution, you can make a nondeductible IRA contribution. Going this route preserves the tax deferred nature of growth within the IRA. But once age 59.5, you’ll still owe tax on the gain when you withdraw it (unlike tax free withdrawals from a Roth IRA).
When correcting this way, you don’t have to withdraw the growth apportioned to the excess Roth IRA withdrawal. So you avoid tax and the 10% penalty on that withdrawal.
Note, you will need to file Form 8606 with your tax return to report the nondeductible IRA contribution.
3. Remove the excess withdrawal after the tax filing deadline:
So you filed your tax return (including extension) and discover the excess contribution after the fact. It’s still important you withdraw the excess amount.
You will follow the same steps as you would if withdrawing the excess contribution prior to the filing deadline. The major difference, however, is you will owe a 6% excise tax each year until the excess contribution is removed. This excise tax will be calculated on Form 5329 when preparing your tax return.
4. Apply the contribution to a future year:
If you were over the income limit in a year you contributed or if you contributed above the annual limit, you can apply the excess contribution toward a future year and forego removing it. In doing so, you will incur the 6% excise tax, but it will be limited to one year, assuming the excess contribution is applied to the following tax year. You will also need to confirm that your income in the following year is below the income limit.
As with most mistakes, there is benefit in correcting the issue as soon as you become aware of the problem. By addressing the excess contribution by utilizing one of the four strategies outlined you can move forward with peace of mind knowing you have limited any future tax penalties with regards to the contribution.