How to Avoid Excess IRA Contribution Penalties

A third scenario involves improper rollovers from qualified retirement plans. When taxpayers roll over required minimum distribution from an employer-sponsored plan into an IRA, the amount is treated as an excess contribution.

Correcting an Excess Contribution

When individuals contribute too much to their IRA, they become liable for a non-deductible 6% excise tax on the amount of the excess. Penalties continue to accrue for every year the excess contribution remains in the IRA (although the total penalty is not to exceed 6% of the value of the account, determined at year-end).

Generally, taxpayers have until the tax filing deadline to remove the excess from the account and report the withdrawal on Form 1099-R. Assuming they have already filed their return, taxpayers may still be entitled to file an amended return by Oct. 15 and remove the excess contribution plus earnings (the IRS provides a formula that can be used to calculate earnings attributable to the excess contribution).

Any earnings must be reported as taxable income — and could also be subject to a 10% early withdrawal penalty if the taxpayer is younger than 59 1/2 and another exception does not apply.

If the taxpayer contributed to both a traditional IRA and a Roth IRA in the same year and exceeded the contribution limit, the excess must first be withdrawn from the Roth. When taxpayers contribute to multiple IRAs for the year, the last contribution is considered the excess contribution.

Taxpayers can also apply the excess to the next year's contribution. For example, if the 2023 excess contribution was $1,500, they need to reduce the 2024 contribution limit by $1,500. The taxpayers will still be subject to the 6% penalty for the 2023 year, but the penalty will not apply in subsequent years.

The excess contribution, however, must be removed from the same IRA to which it was contributed. When a taxpayer has consolidated IRAs, converted to a different type of account or transferred an account to a new custodian before the excess contribution was noticed, the situation becomes more complicated.

In these cases, the taxpayer must determine where the excess funds ended up and withdraw the funds from that account. For example, if the taxpayer made an excess contribution to a traditional IRA and subsequently converted that account to a Roth, the taxpayer must withdraw the excess from that Roth account.

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