If you’re a savvy and planning-oriented individual and you make a Roth IRA contribution for your retirement every year, congratulations. However, there are certain circumstances when this forethought can hurt you.

If you earned more money than you anticipated, got a big bonus or married within the year, you may become ineligible to contribute to a Roth IRA. Under these circumstances, failing to rectify the ineligible contribution can be costly. If your income surpasses the Roth IRA contribution limitations and you contributed anyway, you’ll face consequences. (See: Top 10 Mistakes to Avoid on Your Roth IRA.)

Here is how to get the details about contributing to a Roth IRA and how to rectify a potential mistake if your income exceeds your expectations.

Who Can Contribute to a Roth IRA?

If you’re eligible, a Roth IRA is an excellent account to use for building funds for retirement. (See: How does a Roth IRA grow over time? and 3 Reasons to Convert Your IRA to a Roth IRA.) You’re permitted to contribute up to $5,500 to a Roth and/or traditional IRA, plus an additional $1,000 if you’re age 50 or older. Yet, there are caveats.

Your modified adjusted gross income (MAGI) on your IRS form 1040, affects your Roth IRA contribution status. Earn over a certain amount and you become ineligible to make the Roth IRA contribution. Following are the 2017 IRS rules, by filing status, for contributing to a Roth IRA:

Married filing jointly or qualifying widow(er):

  • If your modified AGI is below $186,000, you can contribute up to the limit.
  • If your modified AGI is between $186,000 and $196,000, your Roth IRA contribution is reduced.
  • If your modified AGI is greater than $196,000, you are ineligible to contribute to a Roth IRA.

Married filing separately and you lived with your spouse for any portion of the year:

  • If your modified AGI is less than $10,000, you can contribute a reduced amount.
  • If your modified AGI is equal to or greater than $10,000, you are ineligible to contribute to a Roth IRA.

Single, head of household or married filing separately and lived apart from your spouse during the year:

  • If your modified AGI is below $118,000, you can contribute up to the limit.
  • If your modified AGI is between $118,000 and $133,00, your Roth IRA contribution is reduced.
  • If your modified AGI is equal to or greater than $133,000, you are ineligible to contribute to a Roth IRA.

Roth Excess Contribution: Taxes, Fines and Fixes    

If you made an excess Roth IRA contribution and do nothing, then you’re levied 6% per year in excise tax until you remove the overpayments and their earnings. Additionally, if you’re under age 59½, you’ll be subject to the 10% early withdrawal penalty.

The optimal fix for the error of over-contributing to a Roth IRA is to remove the excess contributions, plus earnings, from the account before filing your tax return.

If you filed your return early, before removing the contribution-plus-earnings from the account, you might need to file an amended tax return for that year. 

To avoid additional consequences, you must file IRS Form 5329 to report the excess contributions. Form 5329 is regarded as its own tax return, so if you don’t file, the IRS can levy “a failure to file penalty, plus accuracy-related penalties,” according to Jeffrey Levine, chief retirement strategist at Ed Slott & Co. in Rockville Centre, New York, as reported in a recent CNBC article

Another way to undo the excess Roth IRA contribution-plus-earnings and avoid penalties is to recharacterize the contribution and transfer the monies into a non-deductible traditional IRA. You’ll have until October 15 to contact the firm that holds your Roth IRA and request recharacterization of any excess contributions you made the previous year.

The Bottom Line

The best way to avoid this tax mistake is to make your Roth IRA contribution after you know your final year’s modified adjusted gross income. If it turns out that you contributed too much to your Roth IRA, be sure to rectify the error as soon as possible, to avoid additional costs.

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