How to Resolve an Over-Contribution to Your IRA

Even with our best laid plans, sometimes we make mistakes. Perhaps you underestimated your income for the year and contributed more to your IRA than could be deductible; maybe you rolled over an amount that was not eligible for rollover; or maybe you made a contribution to an IRA that you were not eligible to contribute to, such as an inherited IRA. Whatever the case, you have an over-contribution into an IRA and need to take action, otherwise you can be setting yourself up for some penalties and other un-wanted taxation.

Actions for Dealing With an Over-Contribution

You have three options for dealing with the over-contribution situation:  you can pull the over-contribution out; you could also re-characterize the contribution; or you could do nothing.

Pull the over-contribution out. This is known as a corrective distribution. Essentially this is exactly as it sounds: you pull out the money that represents the over-contribution, plus (here’s the wrinkle) any growth or income attributed to the over-contribution. You need to do this by the due date (including extensions) of the tax return for the year of the contribution. In this case “due date” has a special meaning: if you filed your return on time (including extensions) this means October 15 of the year following the year of the contribution, even if you did not use an extension; however, if you did not file your return on time, the deadline is (was) April 15 of the year following the contribution year.

So if you contributed a total of $1,000 more than you were eligible for to your IRA, and there was growth and income of $200 attributable to the over-contribution, you need to withdraw $1,200 before October 15 of the year after your contribution year. And, you’ll need to pay ordinary income tax on the $200 of earnings. Of course if you didn’t file your tax return on time, (actually if you plan to not file your tax return on time) you need to pull out your over-contribution by April 15.

Recharacterize. This method resolves an over-contribution to a Roth IRA, by changing the character of the contribution to a traditional IRA instead of a Roth IRA. This can only be done if you’re eligible to make a contribution (either deductible or non-deductible) to a traditional IRA (you meet the income, other plan coverage, and age limits). To do this you submit Form 8606 to the IRS indicating a change to the over-contribution amount, plus or minus any earnings or losses that have occurred attributed to the over-contribution, from Roth to traditional. This has the same deadlines mentioned above for the corrective distribution. (It should be noted that this type of recharacterization is the only type allowed as of 2018 with the changes to tax law. Previously there were other allowed recharacterizations, from Roth IRA due to conversion, but these are no longer allowed.)

Do nothing. In essence you’re not exactly doing nothing – you’re accepting the fact that the over-contribution occurred, and you’ve chosen to accept the consequences. The consequences are that for any amount you’ve over-contributed, you are subject to a 6% penalty for excess contribution. This may be the best course of action if the over-contribution can be absorbed as a contribution in the following year.

As an example, maybe you made a contribution to your Roth IRA of $5,000 for the year, and it turns out that your income level only allows a contribution of $4,800 – something you didn’t discover until it was too late. The consequence is that you’ll owe a penalty of 6% – $12 total – on the over-contribution of $200. As long as you are eligible to contribute at least $200 to your Roth IRA in the following year (and you don’t over-contribute again), you can pay the penalty and leave the money where it is, considering it a contribution for the following tax year.

Unfortunately, if the over-contribution amount in question is large, this method doesn’t always help. This can be the case if you’ve mistakenly rolled over an inherited IRA into your own IRA instead of an inherited IRA – and you’re a nonspouse beneficiary. If you don’t catch it in time, you will be subject to the 6% penalty for the year of the rollover and every subsequent year thereafter until you distribute the IRA. When you finally catch the mistake (or rather, the IRS catches your mistake, more likely), you’ll be subject to ordinary income tax (and retroactive penalties and interest) on the entire distribution as well, since you effectively treated the IRA as your own money from the very start.