IRAs are a great way to save for retirement, but what happens if you contribute to a Roth IRA and your income is too high? Or you contribute more than you're allowed to a Roth or traditional IRA?

While it would be great if you could put all your money into a Roth (think: tax-free growth and withdrawals), the IRS limits how much you can contribute each year. You must be eligible to contribute based on your income. And if you are eligible, there are limits to the amount you can contribute.

If you make too much money, you might be able to get around income limits with a backdoor Roth.

Likewise, there are contribution limits for traditional IRAs. But the income limits for these IRAs have to do with deducting contributions on your taxes.

If you violate one of the rules, you’ve made an ineligible, or excess, contribution. You’ll owe a 6% penalty on the amount each year until you fix the mistake.

Key Takeaways

  • If you contribute more than is allowed to an IRA, you've made an ineligible (excess) contribution.
  • Ineligible contributions trigger a 6% penalty each year until you remove the excess.
  • You have several options for fixing the mistake, but it's best to act quickly.

IRA Income and Contribution Limits

For 2019 and 2020, the most you can contribute to Roth and traditional IRAs is:

  • $6,000 if you're younger than 50
  • $7,000 if you're age 50 and up

Roth IRAs have an extra restriction. Whether you can contribute up to the limit—or anything at all—depends on your modified adjusted gross income (MAGI). Here's a look at the Roth IRA income limits for 2020:

Roth IRA Income Limits
If your filing status is… And your modified AGI is… You can contribute…
Married filing jointly or qualifying widow(er) Less than $196,000 Up to the limit
  More than $196,000 but less than $206,000 A reduced amount
  $206,000 or more Zero
Single, head of household, or married filing separately and you didn't live with your spouse at any time during the year Less than $124,000 Up to the limit
  More than $124,000 but less than $139,000 A reduced amount
  More than $139,000 Zero
Married filing separately and you lived with your spouse at any time during the year Less than $10,000 A reduced amount
  $10,000 or more Zero

Excess IRA Contributions

If you contributed to a Roth when you made too much to qualify—or if you contributed more than you’re allowed to either IRA—you’ve made an excess contribution. That contribution is subject to a 6% tax penalty.

The $6,000 (or $7,000) maximum is the combined total that you can contribute to all your IRAs. That means if you have a traditional IRA and a Roth IRA, your total contribution to those two accounts maxes out at $6,000 (or $7,000).

The amount you contribute can't be more than your earned income for the year. If your earned income is $4,000, that’s the most you can contribute to an IRA.

The Penalties for Excess Contributions

The penalty for an ineligible contribution is 6% of the excess amount. You pay this penalty when you file your income tax return using IRS Form 5329.

If you don’t fix the mistake, you’ll owe the penalty each year the excess remains in your account. If you’re not eligible to take a qualified distribution from your IRA to fix the mistake, you’ll pay an additional 10% early withdrawal penalty on earnings (interest).

How to Calculate Excess Contributions

The IRS provides a specific formula to calculate earnings (or losses) attributable to an excess contribution.

Net income=excess contribution×ACBAOBAOBwhere:AOB=Adjusted Opening BalanceACB=Adjusted Closing Balance\begin{aligned} &\text{Net income}=\text{excess contribution}\times\frac{ACB-AOB}{AOB}\\ &\textbf{where:}\\ &AOB = \text{Adjusted Opening Balance}\\ &ACB = \text{Adjusted Closing Balance}\\ \end{aligned}Net income=excess contribution×AOBACBAOBwhere:AOB=Adjusted Opening BalanceACB=Adjusted Closing Balance

Adjusted Opening Balance: The previous IRA balance plus all contributions (including the excess one), consolidations, and transfers into the account since the contribution occurred.

Adjusted Closing Balance: The current value of the IRA minus all distributions, consolidations, and transfers since the contribution occurred.

Excess Contribution Example

Here's an example that illustrates a mistake and how to apply the formula to calculate earnings:

Mary contributed $3,000 to her traditional IRA last year. When filing her taxes, she realizes she was only eligible to contribute $2,000 because she only had $2,000 in earned income for the year. She requests to remove the $1,000 excess.

Before the contribution, Mary's IRA balance was $12,000 and it's now worth $18,000. She didn't make any additional contributions or distributions. Her adjusted closing balance is $18,000 and her adjusted opening balance is $15,000 ($12,000 + $3,000). She uses the IRS formula to determine the earnings:

=$1000×$18000$15000$15000=$1000×$3000$15000=$200 earnings\begin{aligned} &=\$ 1000\times\frac{\$ 18000 - \$ 15000}{\$ 15000}\\ &=\frac{\$ 1000\times \$ 3000}{\$ 15000}\\ &=\$ 200 \text{ earnings}\\ \end{aligned}=$1000×$15000$18000$15000=$15000$1000×$3000=$200 earnings

Mary will remove $1,200 ($1,000 excess contribution plus $200 earnings attributable to the excess contribution).

How to Fix an Excess IRA Contribution

There are several ways to correct an excess contribution to an IRA.

  • Withdraw the excess contribution and earnings. In general, you can avoid the 6% penalty if you withdraw the extra contribution and any earnings before your tax deadline. You must declare the earnings as income on your taxes. Also, you may owe a 10% tax for early withdrawal on the earnings if you're younger than 59 ½.
  • File an amended tax return (if you’ve already filed). You can avoid the 6% penalty if you remove the excess contribution and earnings and file an amended return by the October extension deadline.
  • Apply the excess to next year’s contribution. Doing this on a future tax return won’t get you off the hook for the 6% tax this year, but at least you’ll stop paying once you apply the excess.
  • Withdraw the excess next year. If you don't do one of the other options first, you can withdraw the excess funds by Dec. 31 of the following year. You can leave the earnings in, but you must remove the entire excess contribution to avoid that 6% penalty for the following year.

Excess Contribution Considerations

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

  • You must correct the excess from the same IRA. You must remove the excess contribution from the same IRA that triggered the excess contribution. Therefore, if you have multiple IRAs, you can't cherry-pick the IRA you want to "fix."
  • The last contribution is an excess contribution. If you made multiple contributions to an IRA, the last one is considered the excess contribution.
  • You can distribute the entire balance to correct the excess. If the excess amount is the only contribution you made to the IRA—and no other contributions, distributions, transfers, or recharacterizations occurred in the IRA—you can correct the excess by simply distributing the entire IRA balance by the applicable deadline.

The Bottom Line

Most people who make ineligible contributions to an IRA do so accidentally. For example, you could contribute too much if:

  • You make more money, and it pushes you beyond the income eligibility range
  • You forgot about a contribution you made earlier in the year
  • You contributed more than your earned income for the year

In an honest attempt to fund your retirement accounts, you could make an excess contribution. The IRS anticipates that this will happen and provides guidelines to help you fix the mistake.

Of course, the easiest way to fix a mistake is to avoid it to begin with. Pay attention to your earned income, modified adjusted gross income, and the annual contribution limits. Also, keep track of any contributions you’ve already made for the tax year—and be sure you allocate to the correct year any contributions you make between Jan. 1 and April 15.

And, if you do make a mistake, act quickly to fix it so you can limit the penalties you’ll owe.