Important considerations and guidence for excess contributions made in a current or previous tax year.
If you've made excess contributions to your IRA, it’s important to address them promptly. Consulting a qualified tax professional is highly recommended.
Many people accidentally contribute too much to their IRA. Common causes include:
- Earning more income, which pushes you beyond the income eligibility limits.
- Forgetting about a previous contribution made earlier in the year.
- Contributing more than your earned income for the year.
The IRS offers guidelines to help correct the mistake or recharacterize the contribution. However, if you don’t correct the excess contribution, a 6% penalty on the excess amount applies. To avoid this penalty, you must withdraw the excess contribution plus any interest or earnings in the same tax year. If you don't correct the excess, the 6% penalty is applied each year the excess remains. For detailed guidance, consult a tax professional and refer to IRS Publication 590-A, specifically the section "What Acts Result in Penalties or Additional Taxes?"
What is Considered an Excess Contribution?
An excess contribution is any amount contributed to your IRA that exceeds the lesser of:
- Annual limits as published by the IRS, or
- Your gross taxable compensation for the year.
This limit applies regardless of whether the contribution is deductible (Traditional, SEP, or SIMPLE IRA) or nondeductible (Roth IRA). If your employer makes contributions to a SEP IRA on your behalf, refer to Chapter 2 of IRS of Pub. 560.
How to Withdraw the Excess Contributions
- Calculate Excess
The first step is to determine the amount considered excess. IRS Publication 590-A provides detailed instructions on how to calculate this.
Net Income Attributable (NIA) IRS formula is:
Excess Contribution x [ (Adjusted Closing Balance – Adjusted Opening Balance) ÷ Adjusted Opening Balance = Net Income Attributable
To ensure an accurate estimation of earnings on excess contributions, consult with your tax advisor.
2. Submit a Distribution Request
To correct the excess contribution, submit STRATA's IRA Distribution Request. When submitting, choose Excess of Contribution Distribution, choose which tax year you are removing the excess contribution, and if it is the current tax year, provide the NIA amount.
Key Terms:
- Gross Distribution: Total amount that was the "excess" of the allowable contribution amount that will be withdrawn.
- NIA: Total income made on the excess contribution amounts.
- Current Year: Defined by the current tax filing deadline (including extensions) of the current tax year.
Prior Year: Defined as any amount of excess that remained in the IRA account after the tax filing deadline (including extensions) of that year.
Key Considerations When Correcting Excess Contributions
- Same IRA Requirement: You must remove the excess contribution from the same IRA where it was made. If you have multiple IRAs, you cannot transfer the excess to another account.
- Last Contribution is the Excess: If multiple contributions are made to an IRA, the most recent one is treated as the excess contribution.
- Full IRA Distribution Option: If the excess contribution is the only one made to the IRA and no other transactions (contributions, distributions, transfers, or recharacterizations) occurred, you can correct the excess by withdrawing the entire IRA balance by the applicable deadline.
Resources and Calculation Examples:
Net Income Attributable (NIA): What it is, How It Works Examples, Tuovila, Investopedia
Net Income Attributible Formula, Code of Federal Regulations, Title 26