By Sarah Brenner, JD
Director of Retirement Education
You can have too much of a good thing. While saving for retirement with an IRA is a good strategy, there are limits. When a contribution is not permitted in an IRA, it is an excess contribution and needs to be fixed. Here are 5 ways an excess IRA contribution can happen to you:
1. Exceeding the Annual IRA Contribution Limit
You will have an excess IRA contribution if you contribute more than the annual limit to an IRA for the year. For 2022, the limit is $6,000 for those under age 50 and $7,000 for those who are age 50 or over. This may seem like an easy rule to follow. You may wonder who is going around contributing tens of thousands of dollars to IRAs in violation of the contribution limits, especially since most IRA custodians will not accept contributions over the yearly limit. However, an individual with multiple IRAs with different custodians could exceed the limit by contributing to each of them.
2. Not Enough Earned Income
A more common occurrence is an IRA owner not having sufficient earned income or taxable compensation to fund an IRA contribution for the year. While you can use a spouse’s taxable compensation to fund your IRA, you may not use many other different income sources including Social Security, pension, rental, and investment income. You may have a high income, but not be eligible to fund an IRA. If you go ahead anyway, the result is an excess IRA contribution.
3. Too Much Income for a Roth IRA Contribution
A common cause of excess Roth IRA contributions is contributing in a year when income is too high. If your income fluctuates or you have unexpected income in the year, you are particularly vulnerable. Watch out for the annual income limits. For traditional IRAs, there are no income limits for eligibility to contribute, so this is never a problem.
4. Failed Attempts to Rollover
You may be surprised to know that a failed attempt to rollover can result in an excess contribution. How can this happen? Well, there are a variety of ways you can end up in this position. One possibility would be the violation of one of the rollover rules. If you mistakenly roll over after the 60-day rollover period has already expired or if you violate the once-per year rollover rule, you will end up with an excess contribution.
5. RMDs Not Eligible for Rollover
If you are older, you may be at greater risk of excess contribution due to rollover mistakes. This is because of the rule that says that the required minimum distribution (RMD) for the year cannot be rolled over. In fact, the RMD for an IRA must be taken before any of the funds in the IRA are eligible for rollover. For example, an RMD must be taken before doing a Roth IRA conversion. If you mistakenly roll over your RMD, you will end up with an excess contribution.
Fixing an Excess IRA Contribution
Now you know what can cause excess IRA contributions. That is the first step in avoiding them. If despite your best efforts, an excess contribution occurs, the bad news is that the problem will not go away or fix itself. An excess contribution will be subject to penalties each year it remains in the IRA. The good news is that excess contributions can be corrected and often without penalty. For the right fix for your situation, be sure to talk to a knowledgeable tax or financial advisor.