What Happens If You Over Contribute to Your IRA?

There are several ways you might have contributed too much to your IRA. Maybe you contributed the full amount to both a traditional and a Roth IRA. Maybe you set up an automatic monthly contribution and forgot to shut it off before you exceeded your contribution limit. Maybe you got a graduation gift from Granny, and you wanted to take advantage of IRA interest rates even though you were IRA-ineligible. Hey, maybe you just screwed up. It happens. Fortunately, the IRS allows you to fix your mistake. But do it quickly because the IRS also imposes a penalty, and that penalty gets applied annually until you correct the overpayment.

For the years 2015-2018, the IRS limits contributions for people younger than age 50 to $5,500. If your earned income for the year is less than this amount, then you can only contribute an amount equal to your income. Any amount you contribution in excess of these IRS-imposed contribution limits constitutes an excess contribution. Earned income comprises wages, salaries and tips from Box 1 of your W-2; commissions; net self-employment income minus half your self-employment tax; alimony; and tax-exempt military pay.

If you think the high rate of return on some IRA accounts makes up for any penalty for excess contributions, think again. Failing to withdraw the excess contribution before the date your tax return is due – including extensions – could subject you to a 6 percent tax on the amount over your contribution limit. For example, if you contributed $500 more than you were eligible, the excise tax would be $30. An additional $30 must be paid for each year the extra amount stays in the IRA. Generally, you use Form 5329 to report the tax for excess contributions.

If you discover the excess contribution before you file your tax return, you won't have to pay the excise tax if you withdraw the contribution and income earned on the excess contribution. The transaction must be completed by the date – including extensions – your return is due. The withdrawn contribution doesn't need to be reported as income, but you must include any withdrawn investment growth or income as part of your gross income. It will be considered an IRA distribution, which means you'll have to pay a 10 percent tax penalty on the amount as an early withdrawal if you're younger than 59 1/2.

The IRS allows you to account for any investment loss on the excess contribution when figuring the amount to withdraw. In most cases, the amount to withdraw – whatever the investment outcome of the excess contribution -- will be figured by your IRA custodian. For example, if you have a Discover Bank IRA, then you would use your Discover IRA login to contact Discover Bank and find out your withdrawal amount.

If you discover the excess contribution after you've filed your return, you can correct the mistake by using the excess contribution as part of your IRA contribution the following year. For example, if you contributed $500 too much in 2017, you can apply the $500 as part of your IRA contribution for 2018. That would cut your maximum new contribution for 2018 to $5,000 – or $500 less than your earned income total, whichever is lower. You still must pay the 6 percent tax penalty for 2017, but you won't have to go through the mechanics of withdrawing the excess contribution or dealing with investment performance. However, you can deduct only the amount actually contributed – $5,000, for example – in the current year.

If you discover an extra contribution from more than a year earlier, you must pay the 6 percent excise tax for all the years the excess remained in your account, but you can remove the excess contribution without considering it part of your gross income for that year by filing Form 1040X, an amended return. But this stuff gets complicated pretty quickly. If you find yourself in such a situation, contact your IRA custodian and a tax professional to help you get it fixed.

Your combined contribution to a traditional IRA and a Roth IRA determines whether you reach the annual contribution limit. If your overall contribution limit is $5,500, and you put $2,500 in a traditional IRA and $4,000 in a Roth IRA, you've contributed $1,000 too much. The IRS does not allow you to choose which contribution to fix. Contributions first are applied to traditional IRAs, so the excess must be withdrawn from the Roth IRA.