IRS Penalty for Over-Contributing to Roth IRA
The Internal Revenue Service can assess penalties for over-contributing to a Roth IRA. The excess is often due to a simple error and it does not have to be an expensive mistake. The IRS provides several ways to remove excess contributions. If you act in a timely manner, you can avoid most or all of the penalties for adding too much money to your Roth IRA.
Excess Contribution Penalty
When you over-contribute to a Roth IRA, the IRS calls it an excess contribution. The penalty for making excess contributions is 6 percent of the extra money per year until you remove it from the IRA. For example, if you contribute $1,500 too much, you’ll be assessed $90 per year until you take it out of the Roth IRA. You may need to withdraw any earnings attributable to the excess contribution as well.
The annual maximum contribution to a Roth IRA is typically $5,000 or your adjusted gross income, whichever is less. When you reach age 50, this increases to $6,000. If you contribute more, it is an excess contribution. When you have more than one IRA account, the limit applies to your combined contributions to all accounts, including traditional IRA accounts. The amount you can contribute to a Roth IRA is eliminated if your income exceeds IRS limits. If this occurs, money you add to your Roth IRA is an excess contribution. If you roll over funds from another retirement plan incorrectly, the IRS may treat it as an excess contribution. Properly executed rollovers do not count as contributions.
Avoid the Penalty
If you remove an excess contribution by your tax filing deadline the following year, including filing extensions, the IRS does not impose the 6 percent penalty tax. You may remove the extra money, plus earnings, by withdrawing it from your Roth account. You can accomplish the same thing by reducing your current year contributions to your Roth IRA by enough to offset the excess amount including any earnings. You have to report the earnings you take out as income and pay taxes on them. The IRS deems removal of earnings an early distribution and may impose a 10 percent penalty tax on them.
You may be able to avoid the 6 percent on excess contributions and having to pay taxes and penalties on earnings attributable to them by recharacterizing the over-contribution as a contribution to a traditional IRA. Recharacterization simply means you instruct the trustee of the Roth IRA to transfer the excess funds to a traditional IRA before your tax filing deadline, including extensions. You can recharacterize an excess contribution only if doing so won’t result in an excess contribution to the traditional IRA.
Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.