For the 2019 tax year, a single filer can contribute up to $6,000 to a Roth IRA ($7,000 for age 50 and older) if their modified adjusted gross income (MAGI) is less than $122,000.
As their income goes above that, the allowed contribution amount begins to decrease until they become totally ineligible at $137,000. The limits for those who are married and filing jointly are $193,000 and $203,000 respectively.
So what can you do if you saved diligently to your Roth IRA last year but as you are gathering all of the documents to file your taxes you find that your income was too high to actually contribute to a Roth IRA?
There are three fairly straightforward options to remedy this problem.
Withdraw the Excess Contribution
The first solution is to simply withdraw the excess contribution so it doesn’t count toward that year’s contributions.
According to the IRS:
“For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.”
What this means is that withdrawals are not treated as distributions — it’s as though the contributions were never made. But earnings on the contributions will be counted as income and you’ll owe taxes on that amount (you’ll also owe the 10% tax for an early withdrawal if you are under the age of 59 1/2).
For example, if you contributed $6,000 and that $6,000 earned $100 you will need to withdraw $6,100 when removing the excess contribution. Only the $100 of earnings will be considered income though.
You can withdraw contributions from a Roth IRA up until the Oct. 15 extended deadline if you’ve requested an extension of time to file your return. If you already filed your tax return, you can still withdraw contributions, but you’ll need to file an amended tax return after withdrawing the funds.
Move the Money to a Traditional IRA
Another option is to “re-characterize” the Roth IRA contribution to a Traditional IRA contribution.
According to the IRS:
“You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called re-characterizing the contribution. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the tax year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA.”
The IRS says that you must also:
“Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a negative amount. Report the recharacterization on your tax return for the year during which the contribution was made. Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.”
Apply the Roth Contribution to the Following Tax Year
If you expect your income will be low enough that you can contribute to a Roth IRA going forward, you also have the option of applying the excess contributions to the next tax year. This allows you to keep the funds invested in the Roth IRA.
The IRS says:
“If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year.”
what if you don’t take action
If you don’t take any of the actions above, the IRS is going to determine that you made excess contributions and assess an excise tax of 6% to the amount that exceeds your limit for the year. This amount is calculated and reported on Form 5329.
You might say to yourself, “6% doesn’t seem so bad”. But the tax doesn’t just apply to one year, it will continue to be assessed each year for as long as the excess contributions remain in the Roth IRA.
It can be easy to inadvertently contribute too much to your Roth IRA. Luckily, there are a number of easy to administer solutions to fix the problem. Just make sure you take the necessary action so you don’t end up paying the government more money than you need to!