I made an excess contribution to my Roth IRA; how do I fix it?

February 19, 2020

"An excess contribution into a Roth IRA can be a hassle, but it is correctible. The sooner you fix the error, the less painful and less expensive the process will be," writes Jeff Witz, CFP.

I contributed to my Roth IRA during part of the year while finishing my fellowship. Then I began working as an attending and by year end had earned too much income to be eligible to contribute to a Roth IRA. How can I fix this?

The IRS considers this an excess contribution to your Roth IRA. Fortunately, they recognize there are several reasons why this could occur and provide ways to correct it. For example, you could have had a spike in income, you could have accidentally contributed directly to your Roth IRA instead of going through the backdoor IRA, or you just weren’t aware that the IRS sets income limits on contributing to a Roth IRA.

Depending on how quickly you discover the error and correct it, the IRS may not penalize you at all or give you time to fix the error. However, if the money stays in the account long term, the penalties can be severe.

As a reminder, your income plays a significant role in determining whether you can contribute to a Roth IRA. If you file your taxes as single, your ability to contribute to a Roth IRA in 2019 was limited if you earned over $122,000 and was eliminated if you earned over $137,000. For 2020, those amounts have been increased to $124,000 and $139,000.

Also by Jeff Witz, CFP: IRS releases updates for 2020; here’s what you need to know

If you were married filing jointly for 2019, your ability to contribute was limited starting at $193,000 and eliminated at $203,000. Those amounts increased to $196,000 and $206,000 for 2020. If you are married and file separately, your ability to contribute is eliminated at $10,000 of income.

If you earned more than these limits and still contributed to your Roth, you have made an excess contribution, and corrective actions must be taken. The IRS penalty for failing to remove an excess contribution can be substantial: 6% each year the excess amount remains in the account. If you don’t catch the error for many years, the penalty can really add up.

These are your options for correcting an excess contribution:

Withdraw the excess contribution before filing your tax return. The IRS treats this as though the contribution never happened, and the 6% penalty will not apply. You must also remove any earnings on the investments during that time period. The earnings must be included in your income, and you will have to pay income taxes on them. If you are under age 59½, you will also need to pay a 10% early withdrawal penalty, but only on the investment earnings attributed to the excess contribution.

Next: Other options for correcting an excess contributionWithdraw the excess contribution before the Oct. 15 tax extension deadline. If you didn’t catch the error before you initially filed your taxes, you can still withdraw the money and submit an amended tax return up to 6 months after your initial tax filing due date (usually Oct. 15). The same rules as above will apply and there is no additional penalty.

Apply the excess contribution to the subsequent year. If this was a one-time occurrence where your income exceeded the limits but the following year you will be eligible to contribute to a Roth, you can have the excess contribution amount moved to the next year. You will still have to pay the 6% penalty for the current year, but at least you will avoid incurring future penalties. If your income still won’t qualify the following year, this option is not available.

Read: Self-employed? Here’s how you can save for retirement

Withdraw the money at a later time. Some people do not catch their error for years. This can be an expensive mistake, but you will always have the option of taking the money out and correcting the error. However, remember that each year the money stays in the account, you will owe a 6% tax on the excess contribution amount. For example, if you made a $6,000 excess contribution and did not catch the error for 3 years, when you remove the money from the account, you will owe $1,080 in taxes ($6,000 x 6% x 3 years).

An excess contribution into a Roth IRA can be a hassle, but it is correctable. The sooner you fix the error, the less painful and less expensive the process will be. If you discover you made an excess contribution into your Roth IRA, we highly recommend speaking with your financial adviser and CPA to assist you with making the necessary corrections.

The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.