What Corrections to Make if You Overcontribute to Your IRA
IRAs can be a great way to save for retirement, but there are limits on how much you can contribute in a given year. These limits are based on several factors, such as your age, income and filing status. If you exceed those contribution limits, you may be subject to a 6% penalty each year on the excess contribution amount for up to six years or until the excess contribution is corrected.
For example, if you contributed $2,000 more than your annual allowance, you would be assessed a $120 penalty each year until you correct the mistake.
If you discover that you overcontributed to your IRA in 2022, you have following correction options.
- Withdraw the excess contribution and associated earnings – If you discover the excess contribution before filing your taxes, you have until the tax filing deadline (April 18 in 2023) to withdraw the excess contribution and its associated earnings to avoid the 6% penalty. You will need to include Form 5329 with your tax filing to document the withdrawn contributions. Any excess earnings associated with the withdrawn contributions will be taxed as ordinary income and may be subject to a 10% early withdrawal penalty if you are younger than 59 ½.
- File an amended return – If you discover the excess contribution after filing your taxes, you can remove the excess contributions and file an amended tax return. The amended return must be received by the IRS by the October tax extension deadline (October 16 in 2023).
- Withdraw the excess contribution the following tax year – If you miss the deadline for filing an amended return, you can withdraw the excess funds by December 31 of the following year in order to avoid a penalty next year. You will still be assessed a penalty in the current year.
- Apply the excess contribution to next year – You also have the option to apply this year’s excess to next year’s contribution limit. You will still be assessed a penalty in the current year.
When determining a course of action to correct excess contributions, it’s important to be aware of the following rules.
- Your last contribution is the excess contribution – If you made multiple IRA contributions throughout the year, your last contribution is deemed the excess contribution.
- You must correct the IRA that was impacted – You must withdraw excess contributions from the same account to which they were made. You cannot select a different IRA to correct.
- You can withdraw the entire IRA balance as a correction – If you only made one contribution throughout the year and that contribution pushed you over the limit, you can withdraw the entire IRA balance as a correction. To be eligible, the account must have no other transfers, contributions or recharacterizations during the applicable tax year.
Could you use some help navigating your excess IRA contribution? Creative Planning is here for you. We work with clients to navigate a wide range of financial and tax complexities and improve their personal financial outlooks. To learn more, schedule a call with a member of our team.