What Happens if You Contributed Too Much to an IRA?

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What Happens if You Contributed Too Much to an IRA?

A reader named Jim recently wrote in asking how to handle an excess contribution to a traditional IRA. Upon receiving his e-mail I ran a quick search of the archives and was surprised to discover that I hadn’t covered this topic in the past. With the filing deadline almost upon us, I decided it was high time to rectify the situation.

For starters, let’s define our terms. According to the IRS (see Pub. 590):

Generally, an excess contribution is the amount contributed to your traditional IRAs for the year that is more than the smaller of:

• $5, 000 ($6, 000 if you are age 50 or older), or

• Your taxable compensation for the year.

The taxable compensation limit applies whether your contributions are deductible or nondeductible.

Contributions for the year you reach age 70.5 and any later year are also excess contributions.

An excess contribution could be the result of your contribution, your spouse’s contribution, your employer’s contribution, or an improper rollover contribution. If your employer makes contributions on your behalf to a SEP IRA, see Publication 560.

There are a couple of points here…

For starters, you may have noticed that they referred to “IRAs” plural. This is because you can have (and contribute to) more than one IRA at a time. And this isn’t just talking about traditional vs. Roth. You could have multiple traditional IRAs, multiple Roth IRAs, or a combination thereof.

It’s important to note that all of your IRAs (traditional and Roth) share a common contribution limit which currently stands at $5k/year ($6k/year if you’re 50 or older), so don’t contribute more than $5k total.

It’s also important to distinguish between how much you can contribute and how much you can deduct. While the deductibility of traditional IRA contributions is phased out above certain income limits, you can make non-deductible contributions no matter how much you earn. In fact, this is the basis of the contribute-and-convert strategy for funding a Roth IRA (a.k.a., a “backdoor” Roth) if your income is too high to contribute directly.

So… What happens if you make an excess contribution?

The short answer is that you’ll face a 6% annual tax for excess contributions that aren’t removed by the filing deadline — and this penalty will continue year in and year out until you rectify the situation. The good news is that you can buy yourself some time by requesting an extension.

This tax, which is figured using Form 5329, cannot exceed 6% of the total value of your IRAs.

To rectify the over-contribution, you’ll need to withdraw it plus any related earnings before the filing deadline (or extended deadline if you request an extension). You should contact your IRA custodian for instructions on withdrawing the excess contribution and any associated income.

As for the tax treatment of the withdrawn contributions, you’ll need to report it as taxable income if you previously deducted it. Depending on how much time has passed, this can get messy so be sure to read through Chapter 1 of Publication 590 before acting. You will also have to report as taxable income any money earned on the excess contribution, and this amount might be subject to a 10% early withdrawal penalty.

Oh, and if you’ve already filed your 2011 return, don’t fret… You still have six months to withdraw the contribution and file an amended return — this is essentially an after-the-fact extension. Here again, be sure to read through Publication 590 (or seek professional help) to be sure you get the details right.

8 Responses to “What Happens if You Contributed Too Much to an IRA?”

  1. Anonymous

    The question is can I pay into my IRA and reduce my tax payment to the IRS I lost everything in the 2008,9
    I earn less than 24k a year and write a check each year to the IRS.

  2. Anonymous

    So scenario…
    I currently contribute to my TSP via my Navy Pay. My wife works at a well paying job adn we have significant savings already.
    Last year my TSP investment yielded about 28% and the market looks healthy enough to repliccate this year.

    I keep seeing statements regarding overfunding on purpose then just using it as a non-deductable contribution. I have no intention of using the “contribute and convert” model considering my income will be rising steadily in the future.

    Because I am yielding 28%, is it worth is to pay the 6% tax on this excess contribution?
    Lets say I am contributing $10000 instead of the allowed $6000. Is it worth it to just pay the tax on it? Or is there another way to avoid this?
    OR, do I just make the $6000 contribution to TSP as early as possible in the year and then STOP TSP until the beginning of the next year.
    I need help. There is too much going on considering our money market accounts make too much money, too.

  3. Anonymous

    ” 6% annual tax for excess contributions that aren’t removed by the filing deadline — and this penalty will continue year in and year out until you rectify the situation. ”

    This really is astonishing. And punitive. These limits just don’t help those with a real need to save a lot. No wonder people are choosing to vote with their feet and put their money in other places!

    Thanks for the article. V helpful!

    John

  4. Anonymous

    @NICK

    When you say you made too much to contribute why not do a nondeductible IRA or a Roth. If over for Roth do the backdoor rollover. Sure you don’t get the deduction but you do get the tax free growth.

  5. Anonymous

    Great post! I made the mistake of contributing too much to my IRA account last year because I didn’t realize that the limits were in additional to my 401K contributions. I won’t make that mistake again! I would advise anyone who is in a relatively low tax bracket to go with the Roth IRA vs. the traditional.

  6. Anonymous

    I remember discussing this in the comments sections in one of your earlier articles. Good to know that you can essentially ‘undo’ the contributions that exceed the limits, without penalty, as long as it is done before the filing deadlines.

    Nice to see government using a common sense approach.

  7. Anonymous

    I learned this lesson the hard way this year. I made too much money to contribute (yeah, I know – boo hoo for me). The part that blows is that I thought I was doing something good for myself. For the first time in ages, all of the bills were paid off and I was making money to contribute to an IRA.

    Thanks to TurboTax for finding out this kernel of knowledge, the fine folks at ING Direct were able to get me the correct form and transfer the excess to a savings account (for now.)

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