It’s simple to fix excessive Roth IRA contributions.
The constant need for meticulous attention to detail is seen in both tax preparation and retirement savings. If you’re not paying attention or don’t understand the restrictions, it’s shockingly simple to contribute too much to your Roth IRA.
There are three ways to solve the issue. The additional funds can be returned, carried over to the next year, or transferred to a regular IRA.
- The annual Roth IRA contribution ceiling for 2022 is $6,000; if you’re 50 or older, it rises to $7,000 per year.
- Any contributions that are in excess of the cap may be withdrawn and refunded by the Internal Revenue Service (IRS). However, you must do this prior to filing your tax return.
- If you have already submitted your tax return when you realize your error, you can still withdraw the funds until October 15. You must then submit an amended return, though.
- You can postpone your donation until the following tax year. However, this can mean that you can’t make any further contributions that year because you’ll breach the cap once more.
- The funds can be transferred to a conventional IRA. However, this calls for a transfer from trustee to trustee.
Understanding Roth IRAs
You cannot deduct your donations to a Roth IRA from your taxes, unlike standard IRAs. Although contributions are made with after-tax money, you will still receive some advantages.
Most of the time, distributions are tax-free. The taxes on your contributions have already been paid. Earnings are also tax-free, but only under particular conditions. Unlike with a regular IRA, you won’t need to make required minimum distributions (RMDs). As long as you like, you can keep your money in a Roth IRA.
Roth IRA Contribution Limits
In the tax year 2022, the average person may contribute up to $6,000 to a Roth IRA account. If you are 50 years of age or older, you are eligible to make a catchup contribution of an additional $1,000 every year, for a total of $7,000.
Depending on your filing status and modified adjusted gross income (MAGI), contributions may be lowered. To keep up with inflation, these upper limitations are periodically raised. The whole $6,000, or $7,000 if you’re 50 or older, can be contributed starting in the tax year 2022 if your AGI is:
- If you are married and file a combined return, you cannot owe more than $204,000.
- If you’re single, eligible for the head of household filing status, or married and filed separately but didn’t live with your spouse, your income must be less than $129,000.
When these income levels are reached, contribution caps start to decrease. In the tax year 2022, they are zeroed out at an annual income of $214,000 for married individuals filing jointly and $144,000 for single, head of household, and married individuals filing separate returns who did not live with their spouses. If they made less than $10,000, there was a phaseout for married people who filed separate returns and lived with their spouses. If their AGI is $10,000 or more and remains the same in 2022, their contribution limit is $0.
Both regular and Roth IRAs are covered by these contribution caps. If you keep both types of accounts, you cannot contribute $6,000 to one and $6,000 to the other, nor can you contribute $6,000 to more than one Roth IRA. Depending on your age, the total contributions cannot exceed $6,000 or $7,000 annually.
Going Over the Limit
Consider Sarah, who is 45 years old. She falls under the $6,000 annual cap because she has not yet reached 50. So that she can contribute the maximum amount to her Roth IRA by the end of the year, she plans to make a contribution of $600 per month for ten months from March to December.
Then, the following spring, as Sarah is preparing her tax return, she discovers that Roth IRA contributions are also capped depending on income, which she was not aware of when she was making contributions.
Her maximum Roth IRA limit as a single individual starts to decline once her modified adjusted gross income (MAGI) surpasses $129,000. As of 2022, she can no longer make contributions after earning $144,000.
Sarah’s MAGI for the year comes to $135,000 in the end. This comes in the middle of the income range where Roth IRA contributions are gradually eliminated. They finally disappear completely. Actually, Sarah’s $6,000 donation was more than she was permitted to give based on her salary. There are three ways Sarah might resolve this.
How To Withdraw the Excess Contribution
A withdrawal is the removal of assets from a retirement account, so the amount withdrawn doesn’t a person’s contributions for that specific tax year. You may withdraw contributions on or before the deadline for completing your tax return, according to the IRS. In 2022, this occurs on Monday, April 18.
The earnings on the extra donations must likewise be withheld. Earnings are taken into account in the tax year that the excess contribution was paid as well as when they were received.
But if you’ve asked for a longer period of time to submit your tax return, you can still withdraw contributions from a Roth IRA up until the extended deadline of October 17. Distributions are not considered to be withdrawals. They act as a kind of “undo” feature. It appears as though the contribution was not made at all.
If the money you donated earned interest or dividends while it was in the Roth IRA, you must withdraw those earnings together with the principal. 6 If you are withdrawing $1,000 and that $1,000 generated $10 in interest, your total withdrawal would be $1,010, which includes both your initial payment and the interest received on that sum.
This occurs frequently enough that your IRA plan administrator is familiar with how to handle it. To see if the plan can assist you with solving the issue over the phone, try contacting first. You could be required to submit your request in writing by the administrator.
If You’ve Already Filed Your Tax Return
Even if you don’t request an extension, a unique rule allows you to withdraw payments up until October 17. Up to six months after the first due date of your return, you may withdraw all or a portion of the contributions you made to a Roth IRA. For most individuals, this is October 17. After taking the money out of your Roth IRA, you must submit an amended federal tax return.
You might also need to make changes to your state tax return. To be certain, speak with a local tax expert.
Move the Contribution to the Next Tax Year
Additionally, the IRS permits you to carry over any contributions you make into the following year.
Let’s imagine Robert has to withdraw $1,000 from his contributions to the Roth IRA because his salary puts him over the limit. He is permitted to withdraw $1,000 from his 2022 tax year contributions while still making a $1,000 2023 tax year contribution. Retraction and donation are merged into a single action.
Simply inform the IRA plan administrator that a specific contribution amount will be applied to the upcoming tax year.
According to the IRS, if the total contributions for the subsequent year are less than the annual contribution cap, you may apply the excess contribution from one year to the following.
Move the Money to a Traditional IRA
Recharacterizing a donation means transferring the funds to a regular IRA. As opposed to being a Roth contribution, you are now making a traditional IRA contribution. Up until the filing deadline for your tax return, including extensions, you may recharacterize IRA contributions.
According to the IRS, you must have the contribution transferred via a trustee-to-trustee transfer from the first IRA into the second IRA. If the transfer is completed before the deadline for filing your tax return for the tax year in which the contribution was made, you can choose to treat it as having been made to the second IRA as opposed to the first one. Extensions are a part of this.
You must also include any earnings, according to the IRS. The recharacterization must be disclosed on your tax return. The contribution must be seen as having been made on the day it was made to the initial IRA.
If You Do Nothing
By 2022, if nothing is done about your excessive IRA contributions, you’ll be subject to a 6 percent tax. The term “excise tax” refers to this fine. The amount of your donation that exceeds your annual cap is subject to tax. It is disclosed on Form 5329.
6 percent might not seem like a significant amount, in your opinion. If the assets can increase more quickly over time, perhaps you should just leave them in the Roth IRA. If it was just a one-time tax increase, a 6 percent “fine” wouldn’t be all that bad. That’s not the case, though. Every year that the excess contributions are kept in your IRA, a 6 percent excise tax becomes applicable.
Paying the Tax
Alicia made a $6,000 contribution to her Roth IRA. Her actual upper limit, though, was $1,600. Alicia exceeded her allowed contribution to her Roth IRA by $4,400. By October 17, she still hadn’t adjusted the excessive donation. Alicia’s excess contribution, which is $264, is subject to a 6% excise tax.
The following spring, while completing her taxes, she finds the mistake. She chooses not to make any extra Roth contributions as she can contribute $2,200 to her Roth IRA this new year. Her $4,400 in excess contributions are carried over and absorbed into the current year in this case, totaling $2,200. Her new excess amount is $2,200, with a $132 excise tax to match.
In this case, Alicia would shell out $396 in excise tax spread out over two years. By refraining from making any additional contributions to her Roth IRA, the excess contribution will have been eliminated. By the third year, the surplus contribution has been fixed. There wouldn’t be any extra excise taxes paid to the IRS.
Frequently Asked Questions (FAQs)
How would the IRS find out if I overpaid into my Roth IRA?
Your annual contributions will be reported to the IRS by the financial institution that started your Roth IRA.
When you withdraw extra contributions from your Roth IRA, would you be subject to a penalty tax?
If the Roth IRA received gains from your excess contributions, you might be subject to a 10% penalty tax. If you contributed $1,000 in excess of your allowed amount and that money earned $10 while invested, you might be responsible for paying penalty taxes. However, if you remove your excess contributions prior to the deadline of October 17, you will not be charged a penalty tax.