If you contribute more than is allowed to your IRA one year, don't panic: there are ways to correct the mistake. But that correction can be complicated – it's not just a matter of taking out the excess amount you put in – and if you mess up the math, the IRS could determine that the correction did not occur and assess penalties (a 6% excise tax on the excess, to be exact).

### Excess Contributions Include Earnings

In correcting your mistake, you can't just withdraw a sum equivalent to the contribution. The minute you make an ineligible contribution to an IRA, the IRS assumes that money begins to accrue earnings (interest). So you have to calculate what the earnings on your erroneous or excessive contribution are. The earnings on excess IRA contributions are determined for the period during which the excess amount remained in the IRA or as of April 15, the tax filing date (or Oct. 15, if you file for an extension).

A common mistake when calculating excess contributions is to assume that the earnings apply only to the assets in which the contribution was invested. This is not the case. The earnings on excess IRA contributions take into account the performance of all the assets in the IRA.

For example, let's say John contributed an excess amount of $3,000 to his IRA and immediately invested the $3,000 in 100 shares of XYZ stock. John's IRA also includes 100 shares of ZZZ and $5,000 in money-market funds. When John removes the excess contribution, he must base the earnings on the performance of all the IRA assets, not just the XYZ stock. Note also that the excess amount can be removed either in cash, securities or both, provided the value of the assets removed is equal to the excess amount plus earnings.

### The Formula to Calculate Excess Earnings

The IRS offers this formula to calculate excess earnings is a pro-rata allocation of earnings or losses to the excess amount. The formula is as follows:

A quick explanation of the terms used:

**Adjusted opening balance:**The fair market value (FMV) of the IRA at the beginning of the computation period (defined later) plus any transfer credits, contributions (including excess contributions being removed), and amounts recharacterized to the IRA during the computation period**Adjusted closing balance:**The FMV of the IRA at the end of the computation period, plus any transfer debits, distributions, and recharacterizations from the IRA**Computation period:**This begins immediately prior to when the excess amount was contributed to the IRA and ends immediately before the excess contribution is removed. For IRAs that are valued on a daily basis, the beginning of the computation period is the day before the amount was contributed and the ending period is the day before the amount was removed from the IRA. For IRAs that are not valued on a daily basis, the month-end balance, or any other regularly determined FMV that is available before the date the excess amount was contributed is the beginning of the computation period. For instance, if the amount was contributed on January 15, the IRA owner may use the ending value provided on the account statement for December if the FMV for January 14 is not available.

### Examples of Excess Contributions

These two examples illustrate mistakes and how to apply the formula to calculate earnings.

*Example 1 *

Mary contributed $3,000 to her Traditional IRA No.1 on February 15, 2018, for the 2018 tax year. When filing her tax return, Mary realizes that because she did not have eligible earned income, she is not eligible to contribute to her IRA for 2018. To ensure that she removes the correct amount, Mary needs to compute the applicable earnings on the $3,000. Mary's IRA is not valued on a daily basis, so she must use the closing balance provided on her account statement for January 2019, which is $5,400. Mary decides to remove the excess amount on April 15, when the balance of IRA No.1 is $16,800. Between February 15, 2013, and April 15, 2013, Mary transfers $8,000 from her Traditional IRA No.2 to her Traditional IRA No.1. No distributions occurred during that period. Mary computes the earnings as follows:

The earnings on the excess contribution are $73. To correct the excess contribution, Mary must remove $3,073 from IRA No.1. The IRA custodian will issue IRS Form 1099-R for 2018 to report the correction. The form will reflect $3,073 in Box 1 (the total amount distributed), $73 in Box 2a (the taxable amount) and Code 8 in Box 7, to designate that the earnings are taxable in 2013. Mary must add the $73 to her 2013 tax return as taxable income. If she is under age 59.5, she may owe the IRS an early-distribution penalty of $7.3 ($73 x .1).

*Example 2 *

Harry contributed $3,000 to his Roth IRA on June 15, 2018, when the FMV of his IRA was $7,700. In December, after receiving a sizeable bonus, Harry realized that a boost in his annual income meant he was eligible to contribute only $2,500. On January 15, 2019, when his IRA was valued at $10,500, Harry contacted his IRA custodian to have the excess amount of $500 and the earnings removed from his IRA. During the computation period, no transfers or distributions occurred in the IRA. The earnings were computed as follows:

Harry must remove $491 ($500 - $9) from his IRA as a return of excess. He does so by filing Form 5329 with his tax return.

### Considerations in Correcting Excess IRA Contributions

In addition to the formula, there are some fine points to consider in correcting excess or incorrect IRA contributions.

**Excesses must be corrected from the same IRA.****The last contribution is an excess contribution.****Distribution of the entire balance is sufficient for correction of excess.**If the excess amount is the only contribution made to the IRA and no other contributions, distributions, transfers or recharacterizations occurred in the IRA, the IRA owner may correct the excess by simply distributing the entire IRA balance by the applicable deadline.

**Non-timely correction rule does not apply to Roth IRAs.**

### The Bottom Line

In an honest attempt to fund their retirement accounts, many individuals contribute amounts in excess of the allowable limits. The IRS anticipates that this will happen and has provided guidelines to assist individuals in making the corrections.

There is no 6% excise tax if the excess is corrected on time. The key is to keep accurate records of your IRA contributions. This includes tallying contributions made to multiple IRAs. Should you discover that your contribution is in excess of the limits, contact your IRA custodian immediately. The best brokers for IRAs surely have top-notch service to help in these situations.