What Is a Return of Excess Contribution?
Correcting an excess contribution to a retirement account is a formal process for withdrawing the funds and their earnings to maintain tax compliance.
A return of excess contribution is the formal process of withdrawing funds from a retirement account that exceed the annual limits set by the Internal Revenue Service (IRS). This is a specific corrective action required to bring an account back into compliance with federal tax law. When a person contributes too much to an IRA or 401(k), they have made an “excess contribution.” The process of removing these funds is designed to undo the original transaction and avoid tax penalties, provided the correction is made in a timely manner.
Identifying an Excess Contribution
For 2024, individuals can contribute up to $7,000 to a Traditional or Roth IRA, with an additional $1,000 catch-up contribution allowed for those age 50 and over. These limits apply to the total contributions made across all of an individual’s IRAs. An excess contribution can happen if someone contributes to multiple IRA accounts and the combined total surpasses the allowable amount for their age.
A cause of accidental excess contributions to a Roth IRA relates to income, as eligibility to contribute is phased out for higher-income earners. For 2024, the ability for a single filer to contribute begins to phase out with a Modified Adjusted Gross Income (MAGI) between $146,000 and $161,000. A person may make a full contribution early in the year, only to find their income for the year is higher than anticipated, making some or all of their contribution ineligible.
For employer-sponsored plans like a 401(k), the employee deferral limit for 2024 is $23,000, with an additional $7,500 catch-up for those age 50 and older. These limits apply to the employee’s contributions, not the employer’s matching funds. A common scenario leading to an excess contribution involves changing jobs mid-year. An employee might contribute to the 401(k) at their first job and then begin contributing to a new 401(k) at their second job, inadvertently exceeding the total annual deferral limit across both plans.
Calculating the Corrective Distribution Amount
Correcting an excess contribution involves more than just withdrawing the overage amount. The IRS requires that any earnings, or investment gains, generated by the excess funds also be withdrawn from the account. This additional amount is known as Net Income Attributable (NIA). The purpose of withdrawing the NIA is to return the account to the financial state it would have been in had the excess contribution never been made.
The calculation of NIA is based on the overall performance of the entire IRA or 401(k) account during the period the excess contribution was held in it. The financial institution or plan administrator is responsible for performing this official calculation. They use a specific formula provided by the IRS, which considers the opening and closing balances of the account and the amount of the excess contribution to determine the proportional earnings. When an individual identifies an excess contribution, they cannot simply request a withdrawal of the specific dollar amount they over-contributed.
The Correction Process and Deadlines
Once an excess contribution is identified, the first step is to contact the financial institution that holds the IRA or the plan administrator for the 401(k). The account holder cannot unilaterally fix the issue; it must be processed and documented by the custodian to ensure proper tax reporting.
Upon contacting the custodian, the individual must specifically request a “return of excess contribution and its attributable earnings.” Most financial institutions have a dedicated form or a defined internal procedure for handling these requests. This formal request provides the necessary documentation for the custodian to calculate the NIA and issue the corrective distribution.
The deadline is an important element of the correction process. To avoid a 6% excise tax on the excess amount, the corrective distribution must be completed by the individual’s tax filing deadline for the year the contribution was made. This deadline is typically April 15 of the following year, but it automatically includes any extensions filed. Meeting this deadline is the only way to fully reverse the error without incurring an immediate penalty.
Tax Reporting for the Corrective Distribution
After the corrective distribution is received, specific tax reporting is required. The withdrawal consists of two parts with different tax treatments. The principal amount of the excess contribution that is returned is not taxed upon withdrawal. However, if a deduction was taken for the contribution to a Traditional IRA, that deduction must be reversed by amending the tax return if it has already been filed.
The Net Income Attributable (NIA) portion of the withdrawal is considered taxable income. The NIA is taxable in the year the excess contribution was made, not the year the funds were withdrawn. For example, if an excess contribution made in 2024 is corrected in early 2025, the NIA must be reported as income on the 2024 tax return.
The financial institution will issue Form 1099-R to report the corrective distribution. The code in Box 7 of this form is important; codes such as ‘8’, ‘P’, or ‘J’ signify that the distribution was a return of contributions, which helps in reporting it correctly. For returned nondeductible IRA contributions, Form 8606 is used to track the basis and ensure the principal is not taxed. If the correction deadline is missed, Form 5329 must be filed to calculate and pay the 6% excise tax for each year the excess remains in the account.