What You Need to Know about Excess Contributions

Making annual contributions to your IRA is one of the most important ways to ensure your account is growing each year, but sometimes it's hard to keep up with how much you are putting into your accounts. What happens if you accidentally put too much money into your IRA or contribute more than your earned income? What if you contribute regularly to a Roth IRA, but now discover you know longer qualify because of your income level? As nice as it would be to put as much money as you'd like into your retirement accounts, the IRS has rules surrounding these limits and can penalize you if not followed or corrected in a timely manner.

What Is an Excess Contribution?

Generally, an excess or ineligible contribution is one that exceeds the stated IRA contribution limit, though there are many other ways an excess contribution can occur in an IRA. Reasons they can occur include:

• Making a contribution that exceeds the annual contribution limit.
• Making a contribution to a Traditional IRA after age 73.
• Making a contribution to a Roth IRA when your Modified Adjusted Gross Income (MAGI) exceeds the income limit. (See current MAGI limits for single individuals and married couples filing joint returns.)
• Making a contribution that is more than your taxable compensation.
• Making a contribution on behalf of an individual after date of death.
• Making ineligible or improper rollover contributions.
• Rolling over required minimum distributions.

It's important to understand if you've made excess contributions because if it's not corrected, they are taxed at 6% per year for each year the excess amount stays in the account. That means if you don't fix the contribution, you'll owe the penalty tax each year when you file your yearly income tax return.

How Can I Correct Excess Contributions to My IRAs?

The good news is there are solutions if you find you've made a mistake. If you discover that you've contributed excess funds, you have a few options.

Remove the Contribution

You can distribute the contribution and any income it has earned before the tax filing deadline (including extensions) to avoid the 6% penalty. To do this at Quest, you would complete a Distribution Form by Adobe Sign or completing the PDF. You can find these forms on the Quest webpage Downloadable Forms under Account Management. If you have any questions about the process, you can email Distributions@QuestTrust.com.

Please note the distribution of earnings may have tax implications, so we recommend talking to your accountant or tax advisor to discuss the best course of action. For example, you can withdraw contributions from a Roth IRA at any time tax and penalty free, however, the earnings part of the distribution might expose you to an early-distribution penalty, if you are not 59-1/2 or the Roth was not open for 5 years. 

Recharacterize the Contribution

If you've discovered that your MAGI is too high to contribute to a Roth, you can move the contribution and its earnings to a Traditional IRA since this account does not have an income limit to contribute. This is called a recharacterized contribution and is basically a trustee-to-trustee transfer of the contribution from one type of IRA to another. At Quest you can recharacterize cash contributions if you do it before the tax filing deadline. (Quest cannot recharacterize an asset.) To do this, complete a Recharacterization Re-designation of Contribution form. 

Apply the Contribution to Next Year

If you find that you've contributed too much after the October 15 extended deadline, you can typically carry the excess contributions forward as a contribution for the subsequent year, although you would still need to pay the 6% penalty tax for the year of the excess contribution. Just be sure to reduce your contribution the following tax year by the amount you carried forward, or you might exceed the annual limit again. A tax professional can guide you through this process. 

For more information about contributions, including excess contributions to your IRA, see IRS Publication 590-A. If you are interested in opening a retirement account or have questions about contribution limits, we can help. Schedule your free consultation with an IRA Specialist today.