What to Do if You Contributed Too Much to Your Roth IRA
Over-contributing isn't a difficult problem to fix
Tax planning and saving for retirement require a lot of attention to detail on an ongoing basis. You can easily contribute too much to your Roth IRA if you're not on your toes, but you have four options for fixing the problem. All are pretty straightforward—just pick the solution that works best for your goals.
You're Over the Limit
Most people can contribute up to $6,000 to a Roth IRA account as of 2019.
You can make an additional "catch up" contribution of $1,000 a year for a total of $7,000 if you're age 50 or older.
Let's say Sarah is 45 years old and she sees that the $6,000 annual limit applies to her because she's not yet 50. She decides to contribute $600 each month for 10 months from March through December so she's maxed out her Roth IRA contributions by the end of the year.
It sounds like a great plan, right? Not necessarily. As she's working on her tax return the following spring, Sarah realizes that Roth IRA contributions are also limited based on income—something she was unaware of at the time she was making contributions.
A single person's maximum Roth IRA limit begins decreasing when her modified adjusted gross income (MAGI) reaches $122,000. She becomes ineligible at $137,000 as of 2019. The limits for those who are married and filing jointly are $193,000 and $203,000.
It turns out that Sarah's MAGI for the year is $137,000.
This falls in between the starting point and the end point of the income range where Roth IRA contributions are phased out and eventually eliminated entirely. So Sarah's $6,000 contribution was actually more than what she was allowed to contribute based on her income.
What can she do about the extra money she put in the Roth IRA?
Withdraw the Excess Contribution
A withdrawal is the removal of assets from a retirement account so the amount withdrawn does not count toward a person's contributions for that particular tax year. According to the IRS:
"For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn.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."
You can withdraw contributions from a Roth IRA up until the Oct. 15 extended deadline if you've requested an extension of time to file your return. Withdrawals aren't treated as distributions. They're like an "undo" function. It's as though the contribution was never made in the first place.
If the amount of money earned any interest or dividends while it was sitting in the Roth IRA, you must withdraw that income along with the underlying principal. For example, the total amount of your withdrawal would be $1,010 if you're withdrawing $1,000 and that $1,000 earned $10 interest—your original contribution plus the earnings on that amount.
Your IRA plan administrator knows how to handle this situation because it happens often enough. Try calling first to find out if the plan can help you fix the problem over the phone. The administrator might ask you to submit your request in writing.
If You've Already Filed Your Tax Return
There's a special rule that lets you withdraw contributions until Oct. 15 even if you don't file for an extension. You can withdraw some or all of your Roth IRA contributions up to six months after the original due date of your return, which would be Oct. 15 for most people.
Then you must file an amended federal tax return after withdrawing the funds from your Roth IRA. You might also need to amend your state tax return.
Move the Roth Contribution to the Following Tax Year
What if you want to keep your funds invested in the Roth IRA?
The IRS lets you apply any contributions that are over the limit toward the following year.
Let's say Robert needs to withdraw $1,000 of his Roth IRA contributions because he's over the limit based on his income. He can simultaneously withdraw $1,000 from his contributions for tax year 2018 and contribute the same $1,000 for tax year 2019. The withdrawal and re-contribution is combined into one action. Simply instruct your IRA plan administrator that you're applying a certain contribution amount to the next tax year. The IRS says:
"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."
Move the Money to a Traditional IRA
This is referred to as "re-characterizing" an IRA contribution. You're 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. According to the IRS:
"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 re-characterizing the contribution. To re-characterize 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 re-characterize your contribution, you must do all three of the following."
The IRS says that you must also:
"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."
Do None of the Above
There's a special tax just for this situation if you decide to do nothing—an excise tax of 6%. It applies to the amount of your contribution that exceeds your limit for the year, and it's calculated and reported on Form 5329.
You might think that 6% doesn't sound too bad. If the funds can grow faster than that over time, maybe you should just leave the money parked in the Roth IRA. You're right that a 6% "fine" wouldn't be too bad if it was just a one-time tax but, unfortunately, that's not the case.
The 6% excise tax kicks in each and every year "as long as the excess contributions remain in the IRA," according to a PSA distributed to the press by the IRS.
Say Alicia contributed $6,000 to her Roth IRA, but her actual maximum limit was $1,600. Alicia contributed $4,400 more to her Roth IRA than she was permitted to contribute. She didn't correct the excess contribution by Oct. 15. Now Alicia owes a 6% excise tax on her excess contribution, or $264.
She discovers the error the following spring when she's working on her taxes. She's eligible to contribute $2,200 to her Roth IRA for this new year, and she decides not to make any additional Roth contributions. In this situation, $2,200 of her $4,400 in excess contributions is carried over and absorbed into the new year. Her new excess amount drops to $2,200 with a corresponding excise tax of $132.
In this scenario, Alicia would pay $396 in excise tax over two years. The excess contribution has been corrected by not contributing any new savings to her Roth IRA. By the third year, the excess contribution has been fixed and no additional excise tax would be paid to the IRS.