What Can I Do With Money That I Overcontributed to My Roth?
Roth IRA contributions are limited by the adjusted gross income of the IRA owner as well as by the IRS annual maximum contribution limits. It can be easy to over-contribute to a Roth if you underestimate your annual income or you contribute to several IRAs and exceed the total annual maximum. The IRS requires IRA owners to take corrective action on all excess contributions or face a penalty.
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Calculating Excess Contributions
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The first step in correcting an excess contribution is to ensure you actually have one. The IRS limits change from year to year, so it is important to verify that your contributions are indeed over the year's limit. Limits are communicated in IRS Publication 590 each year. The publication usually lists the current limits as well as the limits for the next one to three years.
There are two calculations that determine how much you can contribute to a Roth IRA in any given year. Publication 590 provides two worksheets, numbered 2-1 and 2-2, to calculate your modified adjusted gross income and Roth IRA contribution limits.
Withdraw the Contribution
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The simplest correction for an excess contribution is to withdraw it, along with any earnings. You must complete this withdrawal by your tax filing deadline (April 15 in most cases). There is no penalty for this withdrawal, but you must report the earnings on your 1040 tax form.
Note that if the contribution was part of a conversion, the conversion will be called "failed." Failed conversions are deemed distributions and are subject to penalties. You may be able to avoid this by recharacterization.
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Recharacterization
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If you discover that your modified adjusted gross income is too high for Roth IRA contributions or if the excess is part of a failed conversion, you can move the contribution to a traditional IRA, also known as a recharacterization. This allows you to take a tax deduction for a new contribution and avoid a penalty for a failed conversion.
The total IRA contribution limits do still apply, so you must reduce the amount of the recharacterization by the value of any other traditional IRA contributions you made during the year.
Apply to Next Year
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If the excess contribution does not exceed the total allowable contribution for the next tax year, you may apply it to that year. If you select this option, work with your IRA custodian to assign the proper tax year to each portion of the contribution. This will ensure that your 5498 forms match up with what you have reported to the IRS.
Let It Lie
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If you choose not to take action or if you discover the mistake after your tax filing deadline, you will be assessed a 6 percent excess contribution penalty. The 6 percent penalty also applies if you remove the contribution but do not withdraw the income earned.
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