Exceeding Roth IRA Annual Allowance

By | October 4, 2013

What happens if you contribute more to an IRA than is allowed by law?

The short answer is that there shouldn’t be a tax “penalty” for a Roth IRA principal withdrawal. You would, however, have to pay capital gains taxes on any earnings your excess contribution accrued, just like you’d have to pay on any non-tax advantaged investment. Most taxpayers would be in a better situation if they monitored how much they contributed to their accounts closely.


IRA Excess Contribution

You can withdraw before April 15 with no penalty for the excess contribution. Normally it’s 6% a year for each year you keep an excess contribution in the account. You may be penalized if you had gains on the excess contribution when you withdraw those. For example, if you deposited $6,000 in one year which had gains and is now $6,600. You need to take out the extra $500 contribution at no penalty and then the pro rata amount of the gains on the excess, which would be $50 in this case. You would pay tax on $50 plus a 10% penalty for withdrawal.


Exceeding Roth IRA Annual Allowance

That said, if it’s just that you’re over the income limit and not that you contributed more that $5500, you probably just want to recharacterize the contribution as a traditional IRA contribution and then do a rollover to a Roth IRA.


IRA Recharacterization

If you do the recharacterization, per the IRS, it “will be treated as having been originally contributed to the second IRA, not the first IRA. Presuming you do this before you file your taxes for 2013, you shouldn’t need to do anything extra to inform the IRS. But, assuming you have a work retirement plan (e.g. 401k), you can’t take a tax deduction for that traditional IRA contribution now, and will want to do a backdoor Roth conversion  which will lead to you filing Form 8606 when you do your taxes for the year.

Taxpayers who recharacterize Roth conversions and IRA contributions are faced with the daunting task of calculating the earnings (or losses) on the amount, if such services are not provided by their IRA custodians. Proper calculation of the earnings/loss is as important as the recharacterization itself, and failure to include the correct amount could cause adverse consequences.


Recharacterization Deadlines

You generally can recharacterize your rollover or conversion by October 15 of the following year, regardless of whether you requested an extension to file your tax return. For example, for your conversion to a Roth IRA in 2013, you have until October 15, 2014, to recharacterize. This deadline applies even if:

  • you did not request an extension to file your 2013 tax return, and
  • you file your return on or before April 15, 2014.