Contributing to a Roth IRA can be a great way to save for retirement but putting too much money into your account in any given year can trigger tax penalties. Fortunately, there are several ways to fix the problem and possibly avoid the penalties.
Key Takeaways
- A Roth IRA can help you save for retirement but you have to be careful not to over-contribute.
- You might contribute too much to your Roth IRA if your income takes an unexpected jump, making you ineligible for a full (or any) contribution.
- You might contribute the maximum amount early in the year and then realize at the end of the year that your salary was less.
- You can withdraw the money, recharacterize the excess contribution into a traditional IRA, or apply your excess contribution to next year's Roth.
- You'll face a 6% tax penalty every year until you remedy the situation.
How Excess Roth IRA Contributions Can Happen
There are several reasons why you might contribute too much money to a Roth IRA.
You Earned Too Little
You might overfund your Roth IRA if you earn less for the year than you originally expected. Like traditional IRAs, Roth IRAs must be funded with taxable compensation, which is money you make from a job or self-employment. Investment income doesn't count.
You can contribute the maximum allowed for a tax year or the amount of your compensation, whichever is less. So at least part of your contribution might count as excessive if you made a full Roth IRA contribution at the beginning of the year but didn't ultimately earn that much.
The annual Roth IRA contribution limit for anyone under age 50 is $6,500 in 2023, increasing to $7,000 in 2024. Individuals who are 50 or older can contribute an additional $1,000 catch-up contribution for a total of $7,500 and $8,000 respectively.
You Earned Too Much
A more likely reason for over-contributing to a Roth IRA is that you earned more for the year than you expected and you've already funded your Roth IRA to the max. The law sets income limits on your eligibility for contributing to a Roth IRA as well as on how much you can contribute if you are eligible. Traditional IRAs have no income limits on who can contribute but your income can affect the extent to which your contributions will be tax deductible.
You can't contribute to a Roth IRA if you file your return as a single taxpayer and your modified adjusted gross income (MAGI) in 2023 equals or exceeds $153,000.You're eligible to make a partial contribution if your MAGI ranges from $138,000 to $152,999. You can contribute up to the limit if it's less than $138,000.
You can't contribute to a Roth IRA in 2024 if you're single and your MAGI equals or exceeds $161,000. You're eligible to make a partial contribution if it ranges from $146,000 to $161,000. You can contribute up to the limit if it's below $146,000.
Married couples filing jointly for 2023 can't contribute to a Roth IRA if they earn $228,000 or more. Having a MAGI from $218,000 to $228,000 means that you can make a partial contribution. You're eligible for a full contribution if your income is under $218,000. Those numbers and ranges increase to $240,000 or more (no contribution allowed), $230,000 to $240,000 (partial contribution), and less than $230,000 (full contribution) in 2024.
Bear in mind that IRAs are individual accounts, and spouses can each have their own Roths, if they qualify.
A substantial pay raise or bonus might push you over these limits if you're close to them, resulting in an excess contribution. You can calculate your reduced Roth IRA contribution limit using worksheets provided in IRS Publication 590-A.
3 Ways to Handle Excess Roth IRA Contributions
There are several possible remedies if you find that you've contributed too much to your Roth IRA. You must generally act before your tax-filing deadline for the year, including extensions, to avoid penalties. The penalty is a 6% tax on your excess contributions.
1. Withdraw Your Excess Contributions
You won't face any penalties if you simply withdraw your excess contribution plus any income it has earned by the due date for your tax return, including extensions. But you'll have to include the earnings portion in your taxable income for the year. The technical term for these earnings is net income attributable (NIA).
You can still withdraw the contribution within six months of your tax return's due date excluding extensions even if you've already filed your tax return for the year.
You must "file an amended return pursuant to section 301.9100-2 with FILED written at the top," according to the IRS. The agency indicates that you should "Report any related earnings on the amended return and include an explanation of the withdrawal. Make any other necessary changes on the amended return."
2. Recharacterize Your Excess Contributions
Another option is to recharacterize your excess Roth contributions by moving them into a traditional IRA. You can do that by instructing the financial institution that holds your Roth IRA to transfer the excess amount, plus any income it has accumulated, into a traditional IRA either at that same financial institution (a same-trustee transfer) or another one (a trustee-to-trustee transfer).
The IRS says, "If this is done by the due date for filing your tax return (including extensions), you can treat the contribution as made to the second IRA for that year (effectively ignoring the contribution to the first IRA)."
Note that although the Tax Cuts and Jobs Act (TCJA) banned recharacterizing Roth contributions from a traditional IRA or other tax-advantaged accounts, starting in 2018, that does not apply to recharacterizing excess contributions in this situation.
3. Apply Your Excess Contributions to a Future Year
You can also apply the excess contribution and its earnings to a future year's Roth IRA as long as you stay within the limits for that year. You may still be subject to the 6% penalty for the year in this case.
What Happens If You Don't Remove Excess Roth IRA Contributions?
You'll be subject to a 6% tax penalty year after year if you don't remove any excess Roth IRA contributions from your account.
What Are the Contribution Limits for Roth 401(k) Accounts?
The most you can contribute to a Roth 401(k) for 2023 is $22,500 if you’re under age 50 or $30,000 if you're 50 or older. Those amounts increase to $23,000 or $30,500 in 2024. That amount is the total for designated Roth and traditional 401(k) accounts combined if you have both types.
What Happens If You Contribute Too Much to a Roth 401(k)?
This is unlikely to happen but your employer should return the money to you as a "corrective distribution" if you do contribute more than you're allowed to your Roth 401(k). That distribution will include both your excess contributions and any income earned on them.
The Bottom Line
There are several reasons why you might inadvertently contribute too much to a Roth IRA. Fortunately, there are also several ways that you can correct the problem and possibly avoid any tax penalties. Consult with a tax professional if you're unsure which is the right option for you or exactly how you should go about it.
