According to the Tax Policy Center, nearly 65 million taxpayers own individual retirement accounts, which include traditional IRAs, Roth IRAs, Simplified Employee Pensions (SEP IRAs) and Savings Incentive Match Plans for Employees (SIMPLE IRAs). The IRS sets a limit on how much you can contribute each year. Go over the limit, and you face a 6% excess contribution penalty. Fortunately, there’s an escape clause.

 

The IRS allows you to withdraw excess contributions, without penalty, by October 15 of the year your taxes are due. There are two options.

  • You can withdraw the excess plus earnings, officially called Net Income Attributable (NIA)
  • You can recharacterize the excess. Recharacterizing means transferring the excess contribution plus any gains or losses to another type of IRA, for example, from a traditional IRA to a Roth IRA or the other way around.

 

By the Deadline

Even though you move the excess by the October 15 deadline, the Net Income Attributable (NIA), which is excess plus earnings, is taxable in the year you made the excess contribution. Earnings are based on overall IRA account performance, not just on the performance of the excess funds.  There’s a worksheet in IRS Publication 590-A that will help calculate NIA.

 

Since there’s no penalty for withdrawals made by October 15 of the year following the year you over-contributed, it’s not necessary to file IRS Form 5329 (additional taxes on qualified plans).

 

After the Deadline

What happens if you don’t get the excess out by October 15? It can still be corrected by:

  • Withdrawing the contribution.
  • Carrying forward the excess and using it as a contribution for a future year.
  • Recharacterization is not available after October 15.
  • You will have to pay the 6% penalty for any excess that remains in the IRA past December 31 of the year after the year you made the excess contribution.
  • The 6% penalty applies to each year the excess remains in the IRA past December 31.
  • The penalty is paid using IRS form 5329.

 

Excess contributions can happen because you contributed too much, you made a contribution without having eligible compensation, exceeding the Roth IRA phase out limits, rolling over required minimum distributions or missing the 60-day rollover window. It’s nice to know that you can get excess contributions corrected without penalty. But it’s a lot less work and headaches to make sure you don’t go over the limit in the first place.

 

 

Disclaimer:

This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors; all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investments at 1-888-777-0970 or email us at info@alhambrapartners.com.