This is an excellent question. What happens if you contributed more to your IRA than allowed? Often, these mistakes are caught around the time your trusty CPA is preparing your taxes. Hopefully, they catch the error in time to make adjustments that may ease the 6 percent penalty that’s levied if you contributed more to your IRA last year than you should have.
Annual contribution limits are in place for every retirement plan. The amount you can contribute is determined by the plan you have. So, you need to know your plan’s limit and make sure you don’t exceed that in any given year. You don’t want to find out after it’s too late that you contributed more to your IRA than allowed.
But, it does happen. And, it happens to the best of us. Maybe you forgot you already maxed your limits out and made another deposit that put you over the max allowed. If you use a Roth IRA and got a raise that pushed your modified adjusted gross income over the threshold of $120,000 (single) or $189,000 (married)—you’re not allowed to directly contribute the maximum limit to your account. But, if you didn’t think about that and adjust your deposits to the account, you very well could have exceeded the limits of your plan for the year.
Fortunately, there are a few moves you can make to limit your exposure to the penalty and avoid being taxed twice. If you contributed more to your IRA than allowed and if it’s caught early enough, the IRS might even waive the penalty (if you’re really lucky).
How to correct excess contributions
There are two ways you can claw back any excess amounts you contributed:
If you haven’t filed your tax return yet, you can take a corrective distribution. Withdraw the excess cash—and any income generated by that excess amount—as soon as you can. This move saves you from the 6 percent excess contribution penalty. You’ll add those earnings to your current income and pay tax on it, but the rest of the overage is free and clear once it’s withdrawn.
You can also reassign some of your overage to the following year. For example, let’s say you contributed $2k more than you should have in 2018. Before filing your taxes, you can actually designate that $2k to go towards 2019 contributions. You’ll pay the 6 percent penalty, but you’re still coming out better than paying tax twice on the excess contribution.
Additional reading on this subject: