What happens if you contribute too much to your Roth IRA? Believe it or not, it’s much easier to do than you might think. How? Suppose you max out your Roth IRA contribution at the beginning of the year, then as the year progresses, you receive a raise, a bonus, or perhaps your spouse goes from unemployed to employed. All of these events could increase your Modified Adjustable Gross Income (MAGI).
If changes in your MAGI and what you earn are substantial, it’s quite possible that your maximum Roth IRA contribution limit for the year will decrease – maybe even to zero. Under such circumstances, if you’ve already made a Roth IRA contribution assuming a certain contribution limit and that limit subsequently decreases, then the result is an excess Roth IRA contribution.
For instance, a few years ago, I inadvertently contributed too much to my Roth IRA. How? At the beginning of the year, I set up an automatic monthly withdrawal with my discount broker. Each month, the same set amount of money would be directly deposited into my Roth IRA from my bank account. This worked well for several months, then I came into a small windfall of cash. I decided to use it to max out my Roth IRA for the year, which I did. However, I forgot to put a stop to the automatic monthly withdrawals, so when the next month came around, I ended up exceeding my Roth IRA contribution limit for the year.
While it’s against IRS rules to contribute more to your Roth IRA than your maximum allowable limit, if you do so inadvertently, it’s not the end of the world. It’s highly unlikely the IRS will throw you in jail for such an offense, and fixing an excess Roth IRA contribution is rather easy.
Fixing Your Excess Contribution
As soon as you realize you’ve made an excess contribution to your Roth IRA, contact your broker and ask for a Distribution Request Form (example – here’s the TD Ameritrade distribution request form). You can get the similar form by searching your broker’s site easily.
You’ll need to fill out this form in order to notify both your broker and the IRS of any distribution from your Roth IRA.Complete all the requested information on the form, and where it asks you for your “Reason for Withdrawal,” check “Refund excess contribution for tax year (20__).
From IRS guidelines – If you timely filed your 2012 tax return without withdrawing a contribution that you made in 2012, you can still have the contribution returned to you within 6 months of the due date of your 2012 tax return, excluding extensions.
Request a withdrawal for the full amount of the access contribution as well as any earnings which resulted from the excess contribution. Once you receive the refund of your excess contribution and any associated earnings, that should be the end of the matter. Removal of an excess Roth IRA contribution is not considered an early withdrawal subject to income taxes or the 10% early withdrawal penalty.
The Excess Contribution Removal Deadline
Once you recognize you have an excess Roth IRA contribution, you have until the day you file your tax return in order to remove the excess contribution. If you file your taxes before you remove the excess contribution, you may be subject to the excess contribution penalty.
If this happens, you still have time to avoid the penalty. As long as you withdraw the excess contribution within six months and avoid the excess contribution penalty if you file an amended return with the phrase “Filed pursuant to Section 301.9100-2” written at the top.
For example, suppose you contribute $5,000 to your Roth IRA in January, but after a banner year at work (which includes several performance bonuses), you learn that your maximum Roth IRA contribution for the year can not exceed $2,500.
As long as you remove the $2,500 excess contribution and its associated earnings by the time you file your taxes, you avoid the negative impact of any penalties. But if you fail to remove the excess contribution by the time you file your taxes, and you then fail to file an amended return within 6 months, you will likely get hit with an annual excise tax known as the excess Roth IRA contribution penalty.
Annual 6% Excise Tax
If you fail to remove your excess Roth IRA contributions and associated earnings in time, you most likely will have to pay a 6% excise tax on those funds each year until the excess contributions and earnings are removed.
For example, let’s say you contribute $5,000 to your Roth IRA, but after filing your taxes, you later learn that your increased earnings made you ineligible to make a Roth IRA contribution.
Under such a scenario, you’re subject to an annual 6% excise tax on the excess contribution until it’s removed. This means you must pay $300 ($5,000 x 6%) annually to the IRS until the excess contribution is removed.
While it doesn’t seem so at first glance, accidentally making an excess Roth IRA contribution is rather easy to do. Fortunately, it’s also rather easy to fix. But if you don’t fix it in time, be prepared to pay an annual penalty until you do.
Britt Gillette is the creator of Your Roth IRA, an online resource for helping you understand and manage your Roth IRA.