What Happens If You Contribute Too Much to an IRA?

Individual Retirement Arrangements (IRAs) are tax-advantaged tools for retirement savings. They help individuals accumulate wealth by offering tax benefits on contributions, earnings, or withdrawals, depending on the IRA type. Adhering to annual contribution limits set by the Internal Revenue Service (IRS) is crucial to avoid potential tax complications and penalties.

Understanding Excess Contributions

An excess contribution to an IRA occurs when the amount contributed for a tax year exceeds the allowable limits. For 2024 and 2025, the general annual IRA contribution limit is $7,000 for individuals under age 50. Those age 50 and older can contribute an additional $1,000 as a “catch-up” contribution, bringing their total limit to $8,000. This limit applies to total contributions made across all Traditional and Roth IRAs.

Excess contributions can also occur if contributions are not supported by earned income. For Roth IRAs, eligibility to contribute is tied to Modified Adjusted Gross Income (MAGI). Exceeding certain income thresholds can result in an excess contribution, even if the dollar limit is not met. For example, in 2024, single filers with a MAGI of $161,000 or more are generally ineligible to contribute to a Roth IRA, and joint filers face a similar phase-out starting at $230,000 MAGI.

Penalties for Overcontribution

Failing to correct an excess IRA contribution can lead to a recurring financial penalty. The IRS imposes a 6% excise tax on the amount of the excess contribution. This tax applies annually for each year the excess amount remains in the IRA. For instance, a $1,000 excess contribution could incur a $60 penalty each year until it is removed.

If earnings are attributed to the excess contribution and not handled correctly, those earnings may be subject to income tax. Previously, a 10% early withdrawal penalty applied if the account holder was under age 59½, but the SECURE 2.0 Act removed this penalty on earnings for timely corrections made by the tax deadline.

Methods for Correction

Correcting an excess IRA contribution involves specific steps to avoid or mitigate penalties. The approach depends on when the excess is identified relative to the tax filing deadline.

One method involves removing the excess contribution before the tax deadline, including extensions. This is often the most favorable approach. The excess contribution amount, along with any net income attributable (NIA) to it, must be withdrawn.

The principal amount of the excess contribution itself is not taxable upon withdrawal, provided no deduction was taken for it. Any NIA generated by the excess contribution is taxable income in the year the original contribution was made and must be reported. Contacting the IRA custodian to request a “return of excess contribution” is the procedural step for this removal.

If the excess contribution is discovered and removed after the tax filing deadline for the contribution year, the 6% excise tax will still apply for each year the excess remained in the account. The excess amount and any associated NIA should be withdrawn to prevent future penalties. The NIA remains taxable in the year the contribution was originally made.

For Roth IRA excess contributions due to exceeding Modified Adjusted Gross Income (MAGI) limits, recharacterization is a specific corrective action. This involves treating a contribution made to one type of IRA as if it were made to another, typically moving the Roth IRA contribution and its associated earnings to a Traditional IRA. The deadline for recharacterization is generally the tax filing deadline for the year the contribution was made, including extensions. This process converts an ineligible Roth contribution into a Traditional IRA contribution, which may or may not be tax-deductible depending on income and other retirement plan participation.

Another option for an uncorrected excess contribution from a prior year is to apply it toward a future year’s contribution limit. This reduces the amount that can be contributed in the current year without incurring a new excess. For example, if there is a $1,000 excess from a previous year and the current year’s limit is $7,000, only $6,000 can be contributed in the current year. However, the 6% excise tax will still apply to the excess amount for each year it remained in the account before being applied to the subsequent year’s limit.

Reporting Excess Contributions

After identifying and correcting an excess IRA contribution, proper reporting to the IRS is necessary to ensure compliance.

Form 5329, “Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts,” is the primary form used to report the 6% excise tax on excess IRA contributions. This form must be filed for each year an excess contribution remains in the account, calculating the additional tax owed.

When an excess contribution and its earnings are removed, the IRA custodian typically reports this distribution on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” The earnings portion of the removed excess is generally reported as taxable income on the individual’s Form 1040 for the year the original contribution was made. The principal portion of the distribution is a return of excess contribution and is not taxable.

For recharacterizations, Form 8606, “Nondeductible IRAs,” is used to report the transaction. This form details the movement of funds from one type of IRA to another, treating the contribution as if it were originally made to the second IRA. A statement explaining the recharacterization should also be attached to the tax return.