In eagerness to maximize contributions to their retirement accounts, individuals may accidentally contribute amounts in excess of the allowable limits. Fortunately, the Internal Revenue Service (IRS) allows these excess amounts to be corrected without penalty (provided the correction occurs within a certain time frame) and has provided procedures to assist individuals in correcting the over-contribution.
Over-contribution to 401(k)
The 401(k) contribution limit for 2013 and 2014 is $17,500 (plus $5,500 for catch-up contributions if you are 50 or older) for an individual.
Even if you have enough money to contribute above these limits, your 401(k) plan administrator will likely keep you from contributing too much in one year. However, if you switch jobs during the year, or if you work two jobs and you contribute to a 401(k) with both, the 401(k) contribution limit may be an issue.
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Excess withdrawn by April 15.
According to the IRS, if you over-contribute to your 401(k) in 2013, you have until April 15, 2014, to withdraw the excess amount. The excess amount (plus any earnings on that amount) will be added to your gross income for the year and will be taxed as such.
So if you are under age 50, and you accidentally contributed $20,000 between two employer plans in 2013, you’d have until April 15, 2014, to withdraw the extra $2,500 plus any earnings on the original $2,500. The earnings will be added to your taxable income for the year.
Excess not withdrawn by April 15
So what happens if you don’t notice that you’ve over-contributed to one or more 401(k) plans until after April 15? In this situation, the excess contribution is taxed twice, once when contributed and again when distributed.
Using the example above, if you don’t withdraw that extra $2,500 by April 15, you’ll have to pay income taxes on it. Plus, because that money wasn’t a legitimate contribution to your 401(k), you’ll have to pay taxes on it again when you withdraw it.
Over-contribution to IRAs
For 2013 and 2014, the maximum you can contribute to all of your traditional and Roth IRAs is the smaller of:
- $5,500 ($6,500 if you’re age 50 or older), or
- Your taxable compensation for the year
If you contribute more, you have until April 15 to correct the over-contribution.
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Tax on excess IRA contributions
An excess IRA contribution occurs if you:
- Contribute more than the contribution limit
- Make a regular IRA contribution to a traditional IRA at age 70½ or older
- Make an improper rollover contribution to an IRA
You’ll pay a 6 percent tax penalty on the money for each year it remains in your account.
To avoid the excess contributions tax:
- Withdraw the excess contributions from your IRA by the due date of your individual income tax return (including extensions); and
- Withdraw any income earned on the excess contribution
Correcting an excess contribution requires the use of a specific formula that determines the amount that must be removed. See the IRS website regarding the appropriate form to report the excess contribution.
Roth IRA Over-Contributions
Unlike Traditional IRAs, Roth IRA contributions are subject to income limits and are allowed only if the individual’s modified adjusted gross income (MAGI) falls below certain limits. ROTH IRA contribution limits for 2013 are as follows:
- For married couples filing jointly, the phase-out range for 2013 is $178,000 to $188,000
- For singles, the phase-out range is $112,000 to $127,000
- For a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range is $0 to $10,000
Any Roth IRA contributions for individuals with MAGI in excess of these limits will be excess Roth IRA contributions.
Roth IRA excess contributions removed after the deadline are treated as regular Roth IRA distributions, which means that the amount is tax-free and is not subject to the 10 percent early distribution penalty. However, the 6 percent excise tax will apply for every year the amount remains as an excess contribution in the Roth IRA.
Additional Rules for IRA Over-Contributions:
Excess contributions must be corrected from the same IRA.
The excess contribution must be removed from the IRA to which the amount was contributed. Therefore, an individual with multiple IRAs cannot pick the IRA from which the correction will occur.
Last contribution is excess contribution.
If an individual made multiple contributions to the IRA, the last amount contributed is deemed to be the excess contribution.
The key is to keep accurate records of your retirement contributions. Should you discover that your contribution is in excess of the limits, contact your IRA custodian or 401(k) plan administrator immediately.
Finally, as with any issues relating to tax and retirement planning, consult your tax professional for assistance in determining your best course of action.
Lisa Hay, CPA, is President and founder of Ascend Financial, LLC, a fee-only financial and retirement planning firm. You can follow Lisa on Twitter: @lisahaycpa, connect with her onLinkedIn, or email her at firstname.lastname@example.org.