Excess Contributions Tax: What It Is and How to Fix It
Over-contributing to a tax-advantaged account can trigger a recurring penalty. This guide explains how to fix the error and satisfy IRS requirements.
The Internal Revenue Service (IRS) imposes an excess contributions tax on individuals who contribute more than the annual limit to certain tax-advantaged savings accounts. This penalty discourages over-funding these accounts for retirement or healthcare expenses.
Identifying an Excess Contribution
An excess contribution is any amount deposited into a tax-advantaged account that exceeds the maximum limit set by federal law for a given tax year. These limits can change annually due to inflation adjustments. The accounts most commonly affected are those managed directly by individuals, such as Traditional and Roth Individual Retirement Arrangements (IRAs), Health Savings Accounts (HSAs), Archer Medical Savings Accounts (MSAs), and Coverdell Education Savings Accounts (ESAs).
For IRAs, the 2025 contribution limit is $7,000, or $8,000 for those age 50 and over, and total contributions to all your IRAs cannot exceed this limit. An excess contribution can also occur if you contribute more than your taxable compensation for the year.
For HSAs, the 2025 limit is $4,300 for self-only coverage and $8,550 for family coverage. Individuals age 55 and older can contribute an additional $1,000. Contributions from an employer count toward this total limit.
While employer-sponsored plans like 401(k)s have limits, overages are handled by the plan administrator. The responsibility for tracking and correcting excess amounts in personal accounts falls directly on the individual.
The 6% Excise Tax
When an excess contribution is not corrected by the deadline, the IRS imposes a 6% excise tax. This tax is charged for each year the excess amount remains in the account at the end of the tax year.
For instance, if you contribute $2,000 over the IRA limit and fail to remove it, you will owe a $120 tax for that year ($2,000 x 6%). If the excess is not removed by the end of the following year, another $120 tax will be assessed. The tax is calculated on the lesser of the total excess contribution or the total value of the account at the end of the year.
Methods for Correcting an Excess Contribution
The most common approach to avoid the penalty is to withdraw the funds before the tax filing deadline, which is April 15th or October 15th with an extension. To properly execute this correction, you must withdraw the exact amount of the excess contribution plus any net income attributable (NIA) to that excess. NIA represents the earnings or losses generated by the excess funds while they were in the account.
The financial institution holding the account can calculate the NIA for the withdrawal. Removing both the excess and its earnings before the deadline completely avoids the 6% tax for that year.
Another strategy is to apply the excess contribution to a future year’s limit, known as a carryforward. This option does not avoid the penalty for the year the excess was made, and the 6% tax must be paid for that initial year. Applying the excess to the next year prevents the tax from being assessed again in subsequent years.
If the tax filing deadline has passed, a withdrawal can still be made to prevent the 6% tax from recurring. In this scenario, only the original excess contribution amount needs to be withdrawn. This action stops future penalties but does not retroactively eliminate them for years that have already ended.
IRS Reporting and Form Filing
The primary form for the penalty is Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.” If an excess contribution was not corrected in time, this form is used to calculate and pay the 6% excise tax and must be filed with your Form 1040 tax return.
When a timely correction is made by withdrawing the excess and its earnings, the reporting process changes. The withdrawn earnings (NIA) must be reported as “Other Income” on Schedule 1 of Form 1040 for the year the excess contribution was made. The principal amount of the excess contribution that was withdrawn is not taxed or reported as income, provided it was not deducted.
After the withdrawal, the account custodian will issue Form 1099-R, which reports the distribution. The distribution code in Box 7, such as ‘8’, ‘P’, or ‘J’, signifies to the IRS that it was a return of contributions.
If the tax return was already filed before the correction, an amended return on Form 1040-X is needed to report the withdrawn earnings. For HSAs, excess contributions are tracked on Form 8889.