Contributing too much to a Roth IRA sounds like a great problem to have. “Oh no, I’ve tried to secure my financial future too much!”
Unfortunately, in this case, too much of a good thing can be very bad. Going over the contribution limit for a given tax year is a serious matter that can result in taxes or fees from the Internal Revenue Service. Let’s take a look at how this mistake can happen and what you can do to avoid taxes, fees or other problems.
Why Overcontributions Happen
The main reason most people will accidentally overcontribute to a Roth IRA is a change in income. These people are usually contributing the maximum amount to a Roth every year. Then a change in income lowers their ability to contribute and they don’t realize it until they do their taxes.
The income limit for contributing to Roth IRAs for 2018 is $199,000 for individuals who file “married filing jointly” tax returns (in 2019, the limit is $203,000). For singles, it’s $135,000 ($137,000 in 2019). Between those numbers and $189,000 for married ($193,000 in 2019) or $120,000 for singles ($122,000 in 2019), you can contribute a reduced amount to a Roth, but not the whole allowable contribution.
If you’re married and your income was normally around $170,000 per year, you wouldn’t need to worry about hitting the limit. But this year you received a bonus at the end of the tax year and it pushed you over the edge. Now your contribution limit is lower or outright eliminated.
Again, you would rather contribute too much than too little. And contributing too much can be fixed without costing you any money. You just can’t wait to act.
Three Ways to Deal with Contributing Too Much
If you find you’ve contributed too much, there are three ways to resolve the situation. All these remedies should be applied before your tax-filing deadline (including any tax extensions). Since you usually discover the problem while you’re doing your taxes, that means you need to act relatively quickly.
One term to learn first: “net income attributable” or (NIA). This is any income that your overcontribution earned since it was deposited in your Roth IRA. The NIA must be withdrawn along with the contribution itself in order for the correction to be considered finalized.
Also remember that if your income allows a partial contribution, you don’t have to remove everything from your Roth IRA, just the overage.
Recharacterize Your Contribution
Ideally you would be able to recharacterize your extra contributions and any NIA into a Traditional IRA. “Recharacterize” means essentially “I don’t want these to go toward a Roth, I want them to go to a Traditional IRA.” This also assumes you would qualify to contribute to a Traditional IRA for that tax year. This is ideal because you’re still saving for retirement.
Withdraw Your Contribution Overage
If you don’t qualify for a Traditional IRA (and thus cannot recharacterize your overage), you can simply withdraw the extra contribution and any NIA.
Apply Your Contribution to a Future Year
You can also apply the excess contribution and NIA to a future year. You may have to pay a 6 percent tax to the IRS to be able to do this.
Ideally you just move your overcontribution (all or part of what you contributed to your Roth, depending on your income status, plus any NIA) into a Traditional IRA. That way you’re still sticking the money in an investment for your financial future. That’s the best result.
If you can’t do that, you should find other investment uses for your overcontribution after you withdraw it (and any NIA). You could, for example, up your 401(k) contributions at work. You could also withdraw the overage for last year and then recontribute it in the next tax year.