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Retirement

How To Fix Overcontributions To Your IRA (step-by-step)

Overview

  • The contribution limits for a traditional IRA and Roth IRA are $6,000 ($7,000 if age 50+) in 2022 and $6,500 ($7,500 if age 50+) in 2023. Any contributions over the contribution limit is considered an excess contribution and must be fixed as soon as possible.
  • There is a 6% excise tax on the overcontributed amount every year you fail to correct the mistake.
  • If you haven't filed your taxes yet, withdrawing the excess contributions before the tax filing date would avoid the 6% excise tax. If you're under 59½ years old, you may have to pay an early distribution penalty of 10% on the overcontributed amount.
  • If you already filed your taxes, you have until the extended deadline in October to withdraw the money and amend your tax return. If you're under 59½ years old, you may be hit with the 10% early distribution penalty.
  • You could also choose to carryover the excess contributions into the next tax year. You'll be hit with the 6% excise tax once, and then the amount would get credited into next year's contribution limit.

An IRA overcontribution occurs when you contribute more money to your Individual Retirement Account (IRA) than the IRS allows in a given year. This can happen if you make a mistake when calculating your contribution, or if you change your mind about how much you want to contribute. If you contribute more than the maximum amount to a traditional or Roth IRA, you may be subject to penalties. Here's how to avoid and fix excess deferrals made to your IRA.

IRA Contribution Limits

The contribution limit for an IRA is $6,000 ($7,000 if age 50+) in 2022 and $6,500 ($7,500 if age 50+) in 2023. You cannot contribute more than this amount into a traditional or Roth IRA. If you do, they're considered excess contributions.

Additionally, you can only contribute up to the maximum of your taxable earnings for the year. If you only made $3,000 in 2022, the maximum you can contribute to an IRA is $3,000.

What are the penalties for excess IRA contributions?

If you don't fix your IRA overcontributions by removing them from your account, you'll be hit with 6% penalty fee for every year you fail to make the correction. The penalty is called an "excise tax" and only gets applied to the amount of your excess contribution, not the entire value of your account. Additionally, if you're not eligible to take qualified distributions, you'll also be hit with a 10% early-distribution penalty when you withdraw the money to fix the error.

How does the IRS know you made an overcontribution?

Your plan provider is required to report your contributions to the IRS each year.

How to correct excess IRA contributions

The steps to correcting excess IRA contributions are slightly different if you do it before you file your taxes vs after you file your taxes.

If you spot the error before you file your taxes

Step 1: Withdraw the excess contributions asap

If you notice you made an overcontribution to your IRA, the first thing to do is to take the excess contributions out of your account, including any and all earnings. Let your plan administrator know that you need a correction for excess contributions.

Step 2: Pay taxes on any earnings

If your excess contributions made any earnings while in your account, you'll have to pay ordinary incomes taxes on the earned amount if you're under 59½ years old. You may also have to pay a 10% early distribution penalty.

When is the deadline?

As long as you withdraw the money before the tax filing deadline, April 15, you won't have to pay the 6% excise tax. You can also file for an extension and you'll have until the October extension deadline. You'll only have to pay taxes and an early withdrawal penalty if your overcontribution made any earnings, and you're under 59½ years old.

If you spot the error after you file your taxes

If you spot the excess contributions after you've already filed your taxes for the year, there are several different options you can choose to take.

Option 1: File an amended tax return by the October extension deadline

If you filed your taxes in April, you have until the extension deadline in October to withdraw the money and file an amended tax return. Contact your plan administrator, let me know about the excess contribution, and request a withdrawal for the excess amount, plus any earnings. If you can fix the situation before the October deadline, you'll avoid the 6% excise tax. However, any withdrawals of earnings will still be taxed as regular income. If you're under 59½ years old, you may also have to pay a 10% early distribution penalty.

Option 2: Carryover the excess amount into next year

You also have the option to just leave the money alone, pay the 6% excise tax once, and carryover the excess contribution amount into the new tax year. They'll get counted towards next year's contribution limits, and you'll avoid future penalties.

Option 3: Withdraw the amount next year

Instead of carrying the overcontribution amount over into the next tax year, you could just leave it alone and choose to withdraw it next year. As long as you withdraw it by December 31, the following year, you won't be charged with an additional 6% excise tax.

Option 4: Recharacterize your IRA contribution

This option is only for overcontributions made to a Roth IRA, not a traditional IRA. You can contact your plan administrator and ask them to transfer the excess amount, and any earnings, from your Roth IRA into a traditional IRA. Doing so before the tax filing deadline would avoid the 6% excise tax and the 10% early distribution penalty.

This option is specifically useful if you accidentally contributed to a Roth IRA when your income was over the Roth IRA income limit. The Roth IRA income limit is $144,000 in 2022 and $153,000 in 2023. If your income is higher than that, you are not allowed to contribute to a Roth IRA.

Also read: How to Fix Overcontributions to a 401k

How do overcontributions happen?

Accidentally overcontributing to an IRA account is a common occurrence, and they usually happen due to one of three reasons:

Reason #1: You're over the Roth IRA income limit, but contributed anyways.

The Roth IRA has an income limit; if your income is too high, you're not allowed to contribute. For 2022, you are not allowed to contribute to a Roth IRA if your income is over $144,000. For 2023, you are not allowed to contribute if your income is over $153,000. A traditional IRA does not have any income limits.

Reason #2: You made contributions to multiple IRAs

You're allowed to contribute to both a traditional IRA and Roth IRA. Some people mistakenly believe that having two accounts means you get the full contribution room for each account. Actually, your total contributions to both account cannot be greater than the contribution limit. For example, if you contribute $3,000 to a Roth IRA in 2022 and you're under 50 years old, you can only contribute up to $3,000 into a traditional IRA, for a total of $6,000.

Reason #3: You've set automatic investments

Many people choose to make automatic investments into their IRAs each month, and they could end up adding up to an amount that's higher than the year's contribution limits.

Reason #4: You contributed more than you earned.

You can only contribute up to the maximum of your earned income. If you only earned $5,000 in taxable income, you can only contribute up to $5,000 into your IRA for the year.

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