Traditional individual retirement accounts allow you to sock away money for retirement and defer taxes on the contributions. However, the Internal Revenue Service limits how much you can contribute. As of 2012, people under age 50 can only contribute $5,000 a year. If you contribute more than this amount, the IRS imposes penalties if you don't correct the excess in time.
Amount to Withdraw
To correct your excess contributions, you have to withdraw not only the amount over the limit, but also any earnings. For example, say you put in $5,000 too much and that $5,000 has grown to $5,400. That means you would have to withdraw the entire $5,400. If your excess contributions resulted in a loss, you only have to take out what's left. For example, if you put in $5,000 too much, but it decreased to $4,500, you would only have to take out $4,500.
You don't have to include the contribution portion of the withdrawal in your taxable income if you didn't claim a deduction and you also withdraw the earnings. However, the earnings must be included in your income and are hit with the early withdrawal penalty if you're not 59 1/2 or eligible for an exception. For example, if you have to withdraw an extra $400 in earnings, your taxable income would increase by $400 and you'd potentially owe a $40 penalty.
You have until your tax filing deadline, including any extensions, to withdraw the excess contributions. Typically, the tax filing deadline is April 15, unless you file for an extension, in which case it is October 15. If your withdrawal includes taxable earnings, include those in your income in the year that you take the withdrawal, even if you were correcting excess contributions from a prior year.
Failing to Withdraw
If you don't take out your excess traditional IRA contributions, the IRS imposes a 6 percent penalty each year the problem goes uncorrected. For example, assume you contributed $7,000 too much this year. You'll owe a $420 penalty. If the next year, you apply $5,000 of that as your annual contribution, you'll still have $2,000 in uncorrected excess contributions. So, you'll owe another $120 penalty.
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