Contributing money to a Roth IRA is a good thing. But contributing too much can be a problem, resulting in tax penalties. Fortunately, there are ways to rectify the situation.
- You might find you've contributed too much to your Roth IRA if your income took an unexpected jump, making you ineligible for a full contribution.
- There are several remedies, but you'll want to take action before you file your taxes.
- If you don't fix the problem, you'll face a 6% tax penalty every year until you do.
Three Ways to Deal with Contributing Too Much
If you find you’ve contributed too much, there are three ways to resolve the situation. All of these remedies should be applied before your tax-filing deadline (including any tax extensions) if you want to avoid penalties. Since you'll usually discover the problem while you’re doing your taxes, that means you need to act relatively quickly.
One term to learn first: “net income attributable” or (NIA). This is any income that your over-contribution has earned since it was deposited in your Roth IRA. The NIA must be withdrawn along with the contribution itself in order for the correction to be considered finalized.
Also remember that if your income allows a partial contribution, you don’t have to remove everything from your Roth IRA, just the overage.
Here are your choices:
1. Recharacterize your contribution
One option you may have is to recharacterize your excess contributions and any NIA as contributions to a traditional IRA. This assumes you qualify to contribute to a traditional IRA for that tax year. If you were 70½ or older that year, you aren't eligible for a traditional IRA, even though you were for a Roth IRA, which has no age limits. If you do qualify, a recharacterization is ideal because you’re still saving for retirement.
(Note that the Tax Cuts and Jobs Act banned recharacterizing Roth contributions from a traditional IRA or other tax-advantaged account, starting in 2018. This ban does not apply to recharacterizing excess cash contributions that don't come from one of these sources.)
2. Withdraw your contribution overage
If you don’t qualify for a traditional IRA (and thus cannot recharacterize your overage), you can simply withdraw the extra contribution and any NIA.
3. Apply your contribution to a future year
You can also apply the excess contribution and NIA to a future year's Roth IRA. You may have to pay a 6% tax penalty to the IRS to be able to do this.
What happens if you do nothing? You'll have to pay that 6% tax penalty every year until you've fixed the problem.
Why Overcontributions Happen
The main reason that people accidentally overcontribute to their Roth IRAs is an unexpected increase in income. That can affect the amount they're eligible to contribute, which they may not realize until they do their taxes for the year. By then they may have already funded their Roth IRA to the max.
The income limit for contributing to Roth IRAs for 2019 is $203,000 for individuals who file “married filing jointly” tax returns. For singles, it’s $137,000. If your income is between $193,0000 and $203,000 for marrieds or between $122,000 and $137,000 for singles, you can contribute a reduced amount to a Roth, but not the whole allowable contribution. The IRS provides the formula for determining that reduced amount on its website or you can use a Roth IRA calculator to determine the reduced amount.
For example, if you’re married and your income is around $170,000 a year, you normally wouldn’t need to worry about hitting the limit. But suppose you received a substantial bonus at the end of the tax year and it pushed your income over $193,000. Now your Roth IRA contribution limit would be lower, or you wouldn't be eligible to contribute at all. If you already made your Roth contribution for the year, you'd have a problem.