What Happens If You Contribute Too Much Money to Your IRA?

Can you feel it? Tax season is coming.

I spent the majority of my workday yesterday organizing our preparation questionnaires so we can get to work shortly after the filing season opens on January 20th. And of course, the questions from our clients are already rolling in.

One of my clients realized that he made too much money last year to contribute to his Roth IRA. However, he’s already made his contributions. So what should he do?  There are three easy solutions.

The Limits

For 2014, if you participate in a company sponsored retirement plan, your ability to deduct your traditional IRA contribution is phased out if:

  • As a single filer or head of household, you make between $60,000 and $70,000 of modified adjusted gross income (MAGI). If you earn above $70,000, you don’t get to deduct anything.
  • If you’re married and file jointly with your spouse, and you can make between $96,000 and $116,000 of MAGI.  Again, earnings above $116,000 prevents any deduction.
  • Lastly, for a married individual filing a separate return, the phase-out range is $0 to $10,000. (Yet another reason not to file MFS.)

If you happen to be an IRA contributor who is not covered by a workplace retirement plan but are married to someone who is covered, the deduction is phased out if the couple’s income is between $181,000 and $191,000.

Lastly, for Roth IRA contributors, the MAGI phase-out ranges are as follows:

  • Single Filers and Head of Household: $114,000 to $129,000.
  • Married Filing Jointly – $181,000 to $191,000.
  • Married Filing Separate – $0 to $10,000.

The penalty for contributing too much to an IRA is a 6% excise tax that applies to any excess contributions.

Solution #1 – Withdrawal Your Excess Contributions

Obviously, we can’t all know what we are going to make at the beginning of the year when we start putting money into an IRA. If you find yourself in the enviable position of contributing too much based on your income (or for whatever reason), you can simply withdraw your contributions by the due date of your tax return (including extensions). You also have to withdrawal any earnings that you made on those contributions as well.

Solution #2 – Apply Excess Contributions to a Future Year

You can also apply your excess contributions to a future year, if the amount you apply is less than the limit for the next year. For example, if you realize you have exceeded the income limits for 2014 and want apply your excess contributions to 2015, you can do so as long as the excess contributions are below $5,500.

Solution #3 – Recharacterize Your Contributions

Lastly you can “recharacterize” or reclassify your contributions as a traditional IRA (assuming you qualify), Roth IRA, or a non-deductible IRA, whichever applies.  It’s best to do this by contacting your administrator and having them do a trustee-to-trustee rollover, so you don’t have any unintended consequences of taking money out of your account.

For additional information on everything IRA, see IRS Publication 590.

There’s still an additional money-saving tip that I’m going to have my client take. More on that Friday.