The contribution limits for Traditional and Roth IRAs are as follows:
|UP TO AGE 50||$6000|
|AGE 50 OR OVER||$7000|
Keep in mind: total contributions (between all Traditional and Roth IRAs) cannot exceed these contribution limits. For example, if you have a Traditional IRA and a Roth IRA, you cannot exceed the $6,000 or $7,000 contribution limits (depending on age) between both IRAs.
Contributions for SEP IRAs each year cannot exceed the lesser of: 25% of your compensation, or $57,000 for 2020 and $58,000 for 2021.
How an Excess Contribution Occurs
An excess contribution may occur for a variety of the following reasons:
- Contribution exceeds the annual contribution limit for your age
- Contribution exceeds your earned income
- Contribution made on behalf of an individual after date of death
- Required minimum distribution (RMD) is rolled over
- Depositing an ineligible rollover contribution
- Contribution to a Roth IRA and your modified adjusted gross income (MAGI) exceeded the income limit enforced by the IRS
Correcting an Excess Contribution
- Remove Excess Contribution and Earnings Before Tax Deadline
- Remove Excess Contribution and Earnings After Tax Deadline
1. Remove the overcontribution plus all earnings attributable to that contribution before the tax deadline.
The excess or unwanted IRA contribution amount, plus the net gain or loss, will need to be removed by the tax filing deadline, including an automatic six-month extension from May 17th, 2021. You can simply withdraw the over-contributed funds plus the net gain or loss from your M1 account using the Transfers tab. Please select "Excess Contribution Removal, Before Tax Filing Deadline" as the withdrawal reason. If any earnings are being withdrawn, they should also be considered in the total withdrawal amount.
If you remove the excess contribution after you file your taxes, you may need to file an amended tax return. If you remove the excess in a timely manner, you will owe tax and, if you are under the age of 59½, the IRS 10% additional tax for early or pre-59½ distributions on any earnings, not on the excess contribution.
2. Remove the overcontribution after the tax deadline.
Only the true excess, not a nondeductible contribution, can be removed after the deadline. You may remove only the amount of the excess; no earnings or loss need to be calculated. You will owe the IRS 6% excise tax for every year the excess remains in the IRA. Additionally, you may not deduct the excess amount when filing your taxes. The excess amount removed will not be taxable if your aggregate contributions for the year do not exceed the annual contribution limit. However, if your aggregate contribution limit for the year exceeded the annual amount, then the excess is taxable and would be subject to the IRS 10% additional tax if you are under the age of 59½.
For example, you made a $6,000 Roth IRA contribution but only qualified to make a $4,000 contribution. The $2,000 excess would not be taxed and penalized because it was not more than the annual contribution limit.
3. Carryover method.
You can offset the excess contribution by limiting your annual contribution for the following year to the maximum minus the excess, as long as you qualify to make a contribution. No distribution from your IRA will occur.
For example, if your contribution limit is $6,000 and you exceed it by $2,000, you can offset the excess by limiting your contributions to $4,000 the following year. However, if you use the carry forward method, you are subject to the IRS 6% excise tax because you did not correct the excess by the deadline. You will not be able to recharacterize the carry forward amount to the other type of IRA. For example, if the carry forward amount is in a Traditional IRA, you cannot recharacterize that amount as a Roth IRA contribution.
How to Calculate Net Income Attributable
Net Income = Excess to be removed x ((Adjusted Closing Balance* – Adjusted Opening Balance*)/Adjusted Opening Balance)
Removal of excess plus earnings
Jim, age 42, contributed $7,000 to his IRA in 2020. Jim’s max contribution for 2020 is $6,000 because he is under the age of 50. Jim’s IRA balance before the contribution was $20,000 and is now worth $28,250. Jim has made no additional contributions or distributions. Jim’s Adjusted Closing Balance is $28,250 and his Adjusted Opening Balance is $27,000 ($20,000 + $7,000).
NIA = $1,000 x (($28,250 - $27,000)/$27,000) = $46.30
Jim will remove $1,046.30 ($1,000 in excess contribution + $46.30 earnings attributable to the excess contribution)
Removal of excess minus earnings
Jim, age 42, contributed $7,000 to his IRA in 2020. Jim’s max contribution for 2020 is $6,000 because he is under the age of 50. Jim’s IRA balance before the contribution was $20,000 and is now worth $24,250. Jim has made no additional contributions or distributions. Jim’s Adjusted Closing Balance is $24,250 and his Adjusted Opening Balance is $27,000 ($20,000 + $7,000).
NIA = $1,000 x (($24,250 - $27,000)/$27,000) = -$101.85
Jim will remove $898.15 ($1,000 in excess contribution - $101.85 loss attributable to the excess contribution)
*Adjusted opening balance is an IRA’s opening balance at the beginning of the period the excess was contributed, including any contributions, transfers, rollovers, or recharacterizations in the IRA since the excess contribution was made.
*Adjusted closing balance is an IRA’s closing balance prior to the removal of the excess, plus any distributions (including rollovers, transfers, and recharacterizations) taken from the IRA during the period the excess was in the account.
Keep in mind!
- You will want to remove the amount from the IRA where the contribution was made.
- If you made multiple deposits, the last amount is considered the excess.
- If you contributed to both a Traditional and Roth IRA in the same year, the excess is deemed to have occurred in the Roth IRA.
M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors.