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Do You Have an Excess Contribution in Your IRA?

Estimated reading time: 3 minutes, 5 seconds

Many retirement investors maximize their IRA contributions up to the limit each and every year. The reality for these individuals is leaving no gaps in their retirement savings and positioning themselves for a greater retirement. It should be every saver’s intention to contribute up to the maximum limit to put themselves in the best financial position during retirement years.

But what about those who contribute more than the annual limit? It’s actually more common than you might think, especially for those who hold multiple IRAs and/or enable automatic contributions into their IRAs.

When someone contributes beyond the annual limit to his or her IRA, it’s called an excess contribution.

And when you contribute more than is allowed and don’t correct, you will be forced to pay a penalty tax. Thankfully, IRA holders have up to their tax return due date, plus extensions, to remove excess contributions without penalty.

In addition, those who file taxes on time get an automatic six-month extension. So, if you have excess contributions but file your taxes by Tax Day (April 15, 2019), you have until October 15, 2019, to remove the excess contributions. If you fail to remove them by that time, you must pay a 6% penalty tax on the amount. What’s more, you will continue to pay the penalty tax for every year you don’t remove the excess.

Therefore, for best results, it’s highly recommended excesses are removed prior to the tax filing deadline, plus extensions. You do this by withdrawing the excess, as well as any earnings derived from it, from the IRA prior to the tax deadline.

Generally, you’ll avoid the 6% penalty by removing both, if applicable. Note that any earnings you remove are taxed as ordinary income, and you may have to pay a 10% early withdrawal penalty. You may also file an amended return and remove the excess contribution by that October extension deadline.

But what of those who are unable to correct the excess contributions in time? What are their options?

IRA holders have two other ways to correct an excess contribution after October 15.

The first option is to remove the excess after the extension deadline. But when you remove the excess contribution after the extension deadline, you must take out the excess only (not the net income attributable, or NIA). Of course, you must pay the 6% penalty tax. Additionally, for Traditional IRA holders, you may have to pay a 10% early distribution penalty, unless an exception applies. There’s also a chance you’ll encounter a loss of earnings penalty as well.

The second option is to leave the excess in the account and carry it forward to the new tax year. You can choose to “carry forward” the amount to use toward the next year’s contribution. With this option, you don’t take a distribution, there’s no loss of earnings penalty, the NIA is not calculated, and you will avoid future penalties. However, you still must pay the 6% penalty for the tax year in which the excess contribution occurred.

Of course, you could do nothing at all about the excess, but you will be charged the 6% penalty tax every year as a result.

You can avoid excess contributions altogether by following IRS rules. Some areas to keep top of mind to prevent excess contributions include

  • contributing more than the annual contribution limit,
  • contributing more than one’s earned income,
  • exceeding the modified adjusted gross income limit (if a Roth IRA), and
  • contributing past age 70½ (if a Traditional IRA).

If you fall into any of these situations, please contact your tax professional for further assistance. Also, consult IRS Publication 590-A for more on the topic of excess contributions. For our IRA holders, if you must correct an excess contribution, please complete our IRA Distribution Request form to initiate the correction process.

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