Individual retirement accounts are one way to save for retirement. Funds can be contributed to the account either pretax or post-tax. The funds grow tax deferred, and you withdraw them in retirement where they are either taxed or tax free, depending on how your IRA is set up. Because of the tax benefits of an IRA, contributions are limited; if you exceed the contribution limits, you will be penalized.
An excess contribution is any amount over the annual contribution limit. As of the date of publication, the annual contribution limit is $5,000 a year, or $6,000 a year if you are age 50 or older. The annual limit can also be your taxable income for the year if that amount is lower than $5,000 a year or $6,000, depending on if you are 50 or older. For example, if you only have $4,000 in taxable income in a given year, that is the maximum amount that your can contribute to your IRA. Excess contributions are also any contributions you make for the year that you reach age 70 ½ and thereafter.
Excess Contribution Penalty
If you make excess contributions to your IRA and don’t withdraw the excess amount by the time you file your tax return, then you are liable for a 6 percent penalty tax on the excess amount. The 6 percent penalty will be owed on excess amounts for each year that the excess remains in your IRA. The maximum amount of the tax cannot exceed the value of your IRA.
Carrying Forward Contributions
While you cannot apply an excess contribution to a prior year contribution limit, you may be able to carry it forward. If your contributions in a future year are less than the maximum contribution amount, you can apply any prior year excess contribution amount to the contribution limit of that year. You will still have to pay the 6 percent penalty for the years where the amount was still considered an excess, but you will not need to withdraw any excess amount.
Other Options for Excess Contributions
Rather than waiting to carry over an excess contribution, you can withdraw the excess amount and any interest it earned. This allows you to avoid the 6 percent penalty. If you have already filed your return, you can withdraw it within 6 months of the due date for your tax return. You will need to file an amended return.