The Basics Of A Roth IRA Excess Contribution

A Roth Individual Retirement Account (or Roth IRA) is an account or annuity set up in the United States whose objective is to provide for your future retirement. It can be considered as a “forced savings” plan with you or your dependents as the sole beneficiaries. It is one of several types of IRAs one of which is the Traditional IRA.

Roth IRAs are different from their traditional counterpart, where an investment (in part or in its entirety) is income tax deductible. This means that the investments you make in this IRA (also called “contributions”) are not income tax deductible. Just like all IRAs a Roth IRA has its contribution limits. If you make a contribution or rollover to a Roth IRA that is not permitted, or is larger than the defined limits, this is called a Roth IRA excess contribution. Because this is not allowed, you will need to fix up the problem in the soonest possible time.

There are several ways to find yourself in a Roth IRA excess contribution situation:

1. First, the total amount of your annual contributions to one or more Roth IRAs (and regular IRAs) for one year has exceeded the contribution limits for that year. Second, your total Roth IRA contributions have exceeded your taxable income for the year.

2. Another situation wherein you will be qualified for a Roth IRA excess contribution is when your permitted contribution was reduced or eliminated altogether because of the size of your modified AGI (adjusted gross income).

3. Yet another situation of Roth IRA excess contribution occurs when your rollover (i.e., when you “re-contribute” the earnings of your contribution) contribution does not meet the parameters to qualify for a rollover (e.g., within 60 days, your modified AGI exceeds $100,000, or if you are married and filed a separate return.)

If you fail to rectify your Roth IRA excess contribution in a quick manner, you will be levied a 6% penalty of the excess for every year that the said excess remains uncorrected. If, for example your Roth IRA excess contribution is $1,000 and remains uncorrected for five years, you will be penalized a total of $300.

Fortunately, there are ways to correct a Roth IRA excess contribution. One way is to withdraw (also called “distribution”) the excess (contribution and any earnings). You will be able to avoid the penalty using this method, but only if you receive a distribution from the IRA on or before the due date for filing your return for the year of the contribution and the distribution includes the amount of the excess contribution and the amount of net income attributable to the contribution. This is a simple solution to correct a Roth IRA excess contribution but timing is everything.

The other way to correct a Roth IRA excess contribution is to have the trustee of your Roth IRA make a direct transfer of the excess to a trustee of a regular IRA. This is called Reclassification. Using this approach, you will be able to avoid the penalties but you should again make this effective before the due date for filing your return for the year of the contribution, and the distribution includes the amount of the excess contribution and the amount of the net income attributable to the contribution. Again, a good solution to cure Roth IRA excess contribution but timing really is everything.

The bottom line here is that an IRA is a wonderful instrument to save for your retirement and the Roth IRA is one of these instruments. You just need to be vigilant about situations wherein you have made a Roth IRA excess contribution, and, if you unfortunately do fall under this situation, you take quick action to avoid penalties.

Ira Contribution