What to Do If You Contribute Too Much To Your Roth IRA

What to Do If You Contribute Too Much To Your Roth IRA

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Managing your retirement savings is a crucial aspect of maintaining financial well-being. The Roth IRA stands out among the many retirement vehicles available for its tax advantages and flexibility. However, despite careful planning, it’s possible to contribute too much to your Roth IRA. In this guide, we’ll explore what steps you should take if you find yourself in this situation, ensuring that your financial health remains on track.

Understanding the Roth IRA contribution limits

Before we discuss the steps to resolve an excess contribution, let’s revisit the basics. The Roth IRA, known for its tax advantages, allows eligible individuals to contribute a specified amount each year. However, these contributions are subject to annual limits set by the IRS. For 2024, the contribution limit is $7,000 for individuals under 50 years old, with a catch-up contribution of $1,000 for those 50 and older.

Roth IRA Contribution Limits

Roth IRAContribution Limits 2024
Under Age 50$7,000
Over age$8,000 ($7,000 + $1,000 catch-up contribution)

Recognizing excess Roth IRA contributions

Despite careful planning, it’s possible to unintentionally contribute more than the allowable limit to your Roth IRA. Common scenarios include exceeding the annual contribution limit or making contributions while your income exceeds the eligibility threshold set by the IRS. It’s crucial to identify excess contributions promptly to avoid potential penalties and tax implications.

 

What can cause excessive Roth IRA contributions? 

Several factors exist that could lead to over-contributing funds to a Roth IRA. For instance:

1. Insufficient earnings

One potential scenario involves earning less income during the year than initially anticipated. Roth IRAs are funded with taxable compensation, derived from employment or self-employment.

For example, if your earned income is $3,500 by the end of the year, that’s the most you can contribute to your Roth IRA for 2024. If you made the full contribution to your Roth IRA early in the year but ended up earning less than expected, a portion of your contribution might exceed the allowable limit.

2. You earned too much

 The most likely reason for excessive Roth IRA contributions is that you ended up earning above the Roth IRA income limit. This can sometimes happen if you earn a bonus at the end of the year that pushes you over the income limit, but you have already contributed the full amount to your Roth IRA.

For example, if you file as a single taxpayer, you can’t contribute to a Roth IRA if your MAGI in 2024 equals or exceeds $161,000. If it ranges from $146,000 to $161,000, you’re eligible for a partial contribution. If it’s below $146,000, you can contribute up to the limit.

For married couples filing jointly in 2024, you can’t contribute to a Roth IRA if you make $240,000 or more. If it ranges from $230,000 to $240,000, you’re eligible for a partial contribution. If it’s below $230,000, you can contribute up to the limit.

Roth IRA Contribution Eligibility

Roth IRA Contribution Eligibility - 2024SingleMarried filing jointly
Full contribution< $146,000< $230,000
Partial contribution$146,000 - $161,000$230,000 - $240,000
Not eligible> $161,000> $240,000

What happens if I accidentally contribute too much to a Roth IRA?

The penalty is currently 6% per year for every year the excess contributions remain in the Roth IRA. You pay this penalty when you file your income tax return using IRS Form 5329.

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What should I do if I contribute too much to my Roth IRA?

  1. Assess the situation: Upon realizing you’ve contributed too much to your Roth IRA, assess the extent of the excess contribution. Review your contributions for the current and preceding tax years to determine the amount that exceeds the allowable limit.

  2. Contact your IRA provider: Reach out to your IRA provider as soon as possible to discuss the excess contribution. They can assist you in understanding your options and facilitate the necessary steps to rectify the situation. Prompt communication is key to resolving the issue efficiently.

  3. Request a withdrawal: If you’ve contributed more than the allowable limit for the current tax year, request a withdrawal of the excess amount, along with any associated earnings, before the tax filing deadline. You must also remember to include any of the earnings in your taxable income for the year.

  4. Consider recharacterization: Alternatively, you can recharacterize your excess Roth contributions into a traditional IRA. You can do this by asking the financial institution managing your Roth IRA to transfer the surplus amount, along with any accrued income, into a traditional IRA.

  5. File Form 5329: If you’re unable to resolve the excess contribution before the tax filing deadline, you’ll need to file IRS Form 5329 to report the excess amount. Failure to address excess contributions may result in additional taxes and penalties.

  6. Plan for future contributions: To prevent future occurrences of excess contributions, carefully monitor your contributions and ensure they comply with IRS regulations. Take advantage of available resources, such as contribution calculators and tax guides, to stay informed and make informed financial decisions.

What happens if I don’t remove the excess contribution in time?

Option 1: Apply the excess contribution to the next year
While you will still incur a 6% penalty for the year of the excess contribution, you’ll avoid future penalties. For instance, if the IRA contribution limit is $7,000, and you’ve contributed a total of $8,000, the excess contribution will be $1,000. By applying this excess contribution to the next year’s Roth IRA, your contribution limit for the following year will be reduced by $1,000. While you’ll incur a $60 penalty for the current year’s excess, there will be no penalty in the subsequent year unless excess contributions are made again.

Option 2: Withdraw it the following year
If you’re unable to withdraw the excess contribution before filing taxes, you can still withdraw it afterward. However, you’ll be subject to a 6% penalty tax for each year the excess amount remains in your account. It’s important to note that if you made Roth IRA contributions both earlier and later in the year, with the latter contribution being deemed the “excess contribution,” you cannot withdraw the earlier contribution, even if it would help balance out the excess.

How to calculate earnings on excess Roth IRA contributions

Earnings on excess Roth IRA contributions are known as net income attributable or NIA. You can calculate NIA using the following formula: 

Excess Contribution x [ (Adjusted Closing Balance – Adjusted Opening Balance) ÷ Adjusted Opening Balance = Net Income Attributable

An example of an excess contribution to a Roth IRA

Below is an example demonstrating ‘Elizabeth’ making excessive contributions to her Roth IRA, followed by the formula she utilized to compute the earnings.

Elizabeth contributed $8,000 to her Roth IRA last year. When filing her taxes, she realized that the Roth IRA limit for 2024 was $7,000. She requests to remove the $1,000 excess.
Before her contribution, Elizabeth’s Roth IRA balance was $50,000 and now it’s worth $59,000. She didn’t make any additional contributions or distributions.

Earnings on excess Roth IRA contribution calculation: $1,000 x [(59,000-$50,000)  ÷ $50,000 = $180 earnings

Elizabeth would need to remove $1,180 ($1,000 excess contribution plus $180 earnings from the excess contribution).

Do I have to pay a 10% withdrawal penalty on the excess contribution earnings?

Yes, you still need to pay a 10% early withdrawal penalty on excess Roth IRA contribution earnings. Effectively rectifying the excess contribution before the tax deadline will enable you to avoid the 6% excise penalty. However, you are still liable to pay income tax on those earnings.

If you’re below 59 1/2, the government will impose an additional 10% early withdrawal penalty on any earnings withdrawn. Therefore, in our example above,  Elizabeth would owe $18 of her $180 earnings to the government, in addition to income tax.

What can I do if I make too much to contribute to a Roth IRA?

1. Utilize the backdoor Roth IRA strategy: A backdoor Roth IRA involves making nondeductible contributions to a traditional IRA and then eventually converting those funds into a Roth IRA. Since there are no income limits for traditional IRA contributions, this approach allows high-income earners to indirectly fund a Roth IRA. 

2. Contribute to a Traditional IRA: If your income is too high to contribute directly to a Roth IRA, you still have the option to contribute to a traditional IRA. A traditional IRA doesn’t have any income limits.  While contributions to a traditional IRA may not be tax-deductible for high earners who are covered by an employer-sponsored retirement plan, the earnings within the account can grow tax-deferred until retirement. Additionally, if you’re not covered by an employer-sponsored plan, contributions may be tax-deductible regardless of income level.

3. Maximize contributions to employer-sponsored retirement plans: If you have access to an employer-sponsored retirement plan, such as a 401(k) or 403(b), take advantage of these accounts to maximize your retirement savings. Employer-sponsored plans often have higher contribution limits than IRAs and may offer employer-matching contributions, providing an opportunity to accelerate your retirement savings growth.

4. Look into other investment avenues: Beyond retirement accounts, consider exploring other investment avenues to supplement your retirement savings. Taxable brokerage accounts offer flexibility and accessibility without the contribution limits or restrictions associated with retirement accounts. Investing in a diversified portfolio of stocks, bonds, mutual funds, or exchange-traded funds (ETFs) allows you to build wealth over the long term while maintaining liquidity and control over your investments.

How to request an excess Roth IRA contribution removal in Vanguard

1. Log in to your Vanguard account
2. Select the documents icon in the top right of the navigation menu
3. Select ‘Forms & Applications’
4. Select ‘Add or remove money, trade within your account’
5. Select ‘Remove excess distributions or contributions, convert from a traditional IRA to a Roth IRA, or recharacterize contributions’
6. Select  ‘Remove excess contributions, convert assets or recharacterize contributions’
7. You will be prompted to provide details such as the type of account you will be removing the money from, the amount of the excess contribution, the tax year for which it was made, and any other relevant information.
8. Review the information that you provided. Once you’re satisfied, confirm the request to initiate the removal process. Vanguard usually takes about 2-4 business days to process the request. 

How to request an excess Roth IRA contribution removal in Fidelity

1. Log in to your Fidelity account
2. Once you have logged in to your account, complete the IRA Return of Excess Contribution Request
3. Review the information you’ve provided to ensure accuracy. Once you’re satisfied, confirm the request to initiate the removal process.

Avoid contributing too much to your Roth IRA

Experiencing excess contributions to your Roth IRA can be stressful, but it’s essential to address the issue promptly and take corrective measures. By understanding the contribution limits, communicating with your IRA provider, and following the steps outlined above, you can navigate this situation effectively while maintaining your financial health. 

If you are interested in a comprehensive financial plan, schedule a free discovery consultation with one of our fee-only financial advisors today.

Best Financial Planner Washington DC

Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.

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District Capital is an independent, fee-only financial planning firm. We help professionals and entrepreneurs in their 30s and 40s elevate their finances and maximize their money. We are based in Washington, D.C and we work with people virtually nationwide.

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