What to Do if You Contributed Too Much to Your Roth IRA

Four options for solving the problem of excess Roth IRA Contributions

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Sometimes, people contribute too much savings to their Roth IRA. There are four ways to fix this problem that are all pretty straightforward. Just pick the solution that works best for your goals.

Over The Limit

Is there a way to fix or remedy the mistake of contributing money over the limit for a Roth IRA?

Here's how this gets to be a problem in the first place. People can contribute up to $5,500 into a Roth IRA account, set up in their name.

This is an annual limit. If someone is age 50 or older, they can contribute an additional $1,000, making their maximum a total of $6,500.

So let's say Sam is 45 years old. And she sees that the $5,500 annual limit applies to her because she's under 50 years old. She decides to contribute $550 each month for ten months (from March to December). That way, by the end of the year, she has maxed out her Roth IRA. Sounds like a great plan.

But then next spring, when she is working on her tax return, Sam notices that Roth IRA contributions are also limited based on income. A single person will see her maximum Roth IRA limit decrease once modified adjusted gross income reaches $116,000 (for 2015).  Once modified adjusted gross income reaches $131,000, the maximum amount that a single person can contribute to her Roth IRA is reduced to zero. Sam had contributed to her Roth IRA based on her salary of $100,000.

After bonuses and investment income, it turns out her modified adjusted gross income is $125,000, which falls in between the starting point and end point of the income range where Roth IRA contributions are phased out.

Basically, Sam discovers that her $5,500 contribution was actually more than what she was allowed to contribute based on her income.

Her actual maximum, based on her income for 2015, is $2,200. What can she do about the extra $3,300 she put in the Roth IRA?

Solution #1 is to Withdraw the Excess Contribution.

A withdrawal is the removal of assets from a retirement account, such that the amount withdrawn does not count towards a person's contributions for the particular tax year.

"Withdrawal of excess contributions.  For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made." (Publication 590-A, Contributions to Individual Retirement Arrangements, IRS.gov)

Notice:

  • Contributions to a Roth IRA can be withdrawn on or before the due date for filing the tax return, including any extensions.
  • That means you can withdraw contributions from a Roth IRA on or before the April 15 deadline for the previous tax year.
  • If you have an extension, you can withdraw contribution from a Roth IRA on to before the October 15th extended deadline.
  • Withdrawals are not treated as contributions. Withdrawal is like the un-do function on your computer: it is as if the contribution was never made in the first place.
  • If the amount of money has earned any interest or dividends or other income while it was sitting in the Roth IRA, that investment income is also withdrawn along with the underlying principal. For example, if you are withdrawing $1,000 and that thousand dollars earned $10 interest, the total amount withdrawn is $1,010 – your original contribution that is being withdrawn plus the earnings on that amount.

Your IRA plan administrator knows how to handle this situation. It happens often enough. Try calling them to see if they can help you fix the problem over the phone. Your plan administrator may ask you to submit your request in writing.

That's what happened to Sam. She called her plan administrator, and they asked her to put her request in writing, and then they would follow through with the withdrawal.

Solution #1B is to Withdraw the Excess Contribution Even If You Didn't File for an Extension.

There's a special rule that lets us withdraw contributions until October 15 even if you didn't file an extension. Here's what the IRS says about it:

"If you timely filed your 2014 tax return without withdrawing a contribution that you made in 2014, you can still have the contribution returned to you within 6 months of the due date of your 2014 tax return, excluding extensions. If you do, file an amended return with “Filed pursuant to section 301.9100-2” written at the top. Report any related earnings on the amended return and include an explanation of the withdrawal. Make any other necessary changes on the amended return." (Publication 590-A, Contributions to Individual Retirement Arrangements, IRS.gov)

Let us carefully note what the IRS is saying here.

You filed your personal tax return on or before the deadline, and you didn't request an extension. After filing, you realize you contributed too much money to your Roth IRA.

In this situation, you can withdraw some or all of your Roth IRA contribution as long as you withdraw the money within six months of the original due date of the return. (That would be October 15th for most people.)

After withdrawing funds from your Roth IRA, you then file an amended federal tax return with the IRS using the special procedures outlined above. You might also need to amend your state tax return.

Solution #2 is to Move the Roth Contribution to the Following Tax Year.

What if you want to keep your funds invested in the Roth IRA? We can accommodate that goal. The IRS lets us apply any contributions over the limit towards next year. For example, Robert needs to withdraw $1,000 of his Roth IRA contributions for 2014 because he's over the limit based on his income. He can simultaneously withdraw $1,000 from his contributions for tax year 2014 and contribute the same $1,000 for tax year 2015. The withdrawal and re-contribution is combined into one action where you simply instruct your IRA plan administrator that you are applying a certain contribution amount to the next tax year.

Here's what the IRS says:

"Applying excess contributions.     If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year." (Publication 590-A, Contributions to Individual Retirement Arrangements, IRS.gov)

Solution #3 is to Move the Money to a Traditional IRA.

This is called recharacterizing an IRA contribution. You are changing the character of the contribution from a Roth contribution to a Traditional IRA contribution. You can re-characterize IRA contributions up until the due date of your tax return, including extensions. That means, as long as you get an extension, you can perform a recharacterization by October 15th. Here's what the IRS has to say about recharacterizations:

"You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution."

"To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the tax year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following."

  • "Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount.
  • Report the recharacterization on your tax return for the year during which the contribution was made.
  • Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA."

(Publication 590-A, Contributions to Individual Retirement Arrangements, IRS.gov)

The IRS spells out special rules covering specific situations in the recharacterizations section of Publication 590-A.

Solution #4 is to Do None of the Above and Leave Your Excess Contribution inside the Roth IRA.

There's a special tax just for this situation. It's an excise tax of 6%. The six percent tax applies to the amount of contribution that exceeds your limit for the year. This tax is calculated and reported on Form 5329 (pdf).

You might be thinking, well, six percent isn't too bad. If the funds can grow faster than that over time, maybe I should just leave the funds parked in the Roth IRA. You are right, a six percent fine might not be too bad if it's just a one-time tax. But it's not a one-time tax. The six percent excise tax kicks in each and every year, "as long as the excess contributions remain in the IRA," the IRS notes in a public service announcement distributed to the press (pdf).

What does "as long as the excess contributions remain in the IRA" mean? I'll explain by showing you an example.

Alicia contributed $5,500 to her Roth IRA for tax year 2014. But her actual maximum limit was $2,200. Alicia contributed $3,300 more to her Roth IRA than she was permitted. She didn't correct the excess contribution by October 15th, the extended deadline.  Alicia owes a 6% excise tax on her 2014 excess contribution ($198). She discovers the error next spring when she's working on her 2015 taxes.  Alicia is eligible to contribute $2,200 to her Roth IRA for 2015. She decides not to make any Roth contributions for tax year 2015. In this situation, $2,200 of her $3,300 excess contributions is carried over and absorbed in 2015. Her new excess amount is $1,100 (with a corresponding excise tax of $66).

Let's suppose this same scenario repeats in 2016. Alicia's remaining $1,100 excess contribution gets absorbed by the difference between how much new money she contributes to her Roth IRA and her actual Roth IRA contribution limit for the year.

In this scenario, Alicia pays $264 in excise tax over two years. The excess contribution has been corrected by not contributing new savings to her Roth IRA. By 2016, the excess contribution has been fixed, and no additional excise tax needs to be paid to the IRS.

More about Roth IRAs

More about IRAs