How to Calculate (and Fix) Excess IRA Contributions

Saving for retirement can often be a daunting task. Individual retirement accounts (IRAs) are a great way to save for retirement, but what happens if you contribute to a Roth IRA and your income is too high? What if you contribute more than you're allowed to a Roth or traditional IRA?

Though it would be great if you could put all your money into a Roth (think: tax-free growth and withdrawals), the Internal Revenue Service (IRS) limits how much you can contribute each year. You must be eligible to contribute based on your income. And if you are eligible, there are limits to the amount you can contribute. Likewise, there are contribution limits for traditional IRAs. But, the income limits for these IRAs have to do with deducting contributions from your taxes.

If you violate one of the rules, you’ve made an ineligible (or excess) contribution. This means you’ll owe a 6% penalty on the amount each year until you fix the mistake. Additionally, you will not be allowed to deduct excess contributions from your income as you normally would with traditional IRA contributions.

IRA Income and Contribution Limits

The most you can contribute to Roth and traditional IRAs is as follows:

• $6,500 in 2023 and $7,000 in 2024 if you're younger than 50
• $7,500 in 2023 and $8,000 in 2024 if you're age 50 and up (with a $1,000 catch-up contribution)

Roth IRAs have an additional restriction: Whether you can contribute up to the limit—or anything at all—depends on your modified adjusted gross income (MAGI). Here's a look at the Roth IRA income limits for 2023 and 2024:

Excess IRA Contributions

If you contributed to a Roth when you made too much to qualify—or if you contributed more than you’re allowed to either IRA—you’ve made an excess contribution. That contribution is subject to a 6% tax penalty.

The maximum contribution limit of $6,500 for 2023 ($7,000 in 2024) for IRAs ($7,500 in 2023 and $8,000 in 2024 for those 50 years and older) is the combined total you can contribute to all your IRAs. That means if you have a traditional IRA and a Roth IRA, your total contribution to those two accounts maxes out at $6,500 in 2023 and $7,000 in 2024. Remember, that amount increases to $7,500 in 2023 and $8,000 in 2024 if you meet the catch-up contribution rule.

The Penalties for Excess Contributions

The penalty for an ineligible contribution is 6% of the excess amount. You pay this penalty when you file your income tax return using IRS Form 5329.

If you don’t fix the mistake, you’ll owe the penalty each year the excess remains in your account. If you’re not eligible to take a qualified distribution from your IRA to fix the mistake, you’ll pay an additional 10% early withdrawal penalty on earnings (interest).

How to Calculate Excess Contributions

The IRS provides a specific formula to calculate earnings (or losses) attributable to an excess contribution.

$\begin{aligned} &\text{Net income}=\text{excess contribution}\times\frac{ACB-AOB}{AOB}\\ &\textbf{where:}\\ &AOB = \text{Adjusted Opening Balance}\\ &ACB = \text{Adjusted Closing Balance}\\ \end{aligned}$​Net income=excess contribution×AOBACB−AOB​where:AOB=Adjusted Opening BalanceACB=Adjusted Closing Balance​

• Adjusted Opening Balance: The previous IRA balance plus all contributions (including the excess one), consolidations, and transfers into the account since the contribution occurred
• Adjusted Closing Balance: The current value of the IRA minus all distributions, consolidations, and transfers since the contribution occurred
  

How to Fix an Excess IRA Contribution

There are several ways to correct an excess contribution to an IRA:

• Withdraw the excess contribution and earnings. Generally, you can avoid the 6% penalty if you withdraw the extra contribution and any earnings before your tax deadline. However, you must declare the earnings as income on your taxes. Also, you may owe a 10% tax for early withdrawal on the earnings if you're younger than 59½.
• File an amended tax return if you’ve already filed. You can avoid the 6% penalty if you remove the excess contribution and earnings and file an amended return by the October extension deadline.
• Apply the excess to next year’s contribution. Doing this on a future tax return won’t get you off the hook for the 6% tax this year, but at least you’ll stop paying after you apply the excess.
• Withdraw the excess next year. If you don't choose one of the other options first, you can withdraw the excess funds by Dec. 31 of the following year to avoid the 6% penalty for the next year.

Excess Contribution Considerations

In addition to the formula, there are some fine points to consider in correcting excess IRA contributions.

• You must correct the excess from the same IRA. You must remove the excess contribution from the same IRA that triggered the excess contribution. So if you have multiple IRAs, you can't cherry-pick the IRA you want to "fix."
• The last contribution is an excess contribution. If you made multiple contributions to an IRA, the last one is considered the excess contribution.
• You can distribute the entire balance to correct the excess. If the excess amount is the only contribution you made to the IRA—and no other contributions, distributions, transfers, or recharacterizations occurred in the IRA—you can correct the excess by simply distributing the entire IRA balance by the applicable deadline.

Most people who make ineligible contributions to an IRA do so accidentally. For example, you could contribute too much if you meet the following criteria:

• You make more money and it pushes you beyond the income eligibility range.
• You forgot about a contribution you made earlier in the year.
• You contributed more than your earned income for the year.

In an honest attempt to fund your retirement accounts, you could make an excess contribution. The IRS anticipates that this will happen and provides guidelines to help you fix the mistake.

Example of Excess Contribution

Here's an example that illustrates a mistake and how to apply the formula to calculate earnings.

Mary contributed $3,000 to her traditional IRA last year. When filing her taxes, she realized she could only contribute $2,000 because she only had $2,000 in earned income for the year. She requests to remove the $1,000 excess.

Before the contribution, Mary's IRA balance was $12,000, and it's now worth $18,000. She didn't make any additional contributions or distributions. Her adjusted closing balance is $18,000 and her adjusted opening balance is $15,000 ($12,000 + $3,000). She uses the IRS formula to determine the earnings:

$\begin{aligned} &=\$ 1000\times\frac{\$ 18000 - \$ 15000}{\$ 15000}\\ &=\frac{\$ 1000\times \$ 3000}{\$ 15000}\\ &=\$ 200 \text{ earnings}\\ \end{aligned}$​=$1000×$15000$18000−$15000​=$15000$1000×$3000​=$200 earnings​

Mary will remove $1,200 ($1,000 excess contribution plus $200 earnings attributable to the excess contribution).


What Is the Penalty for Excess Contributions?

If you contribute too much to an IRA, you will pay a 6% penalty on the amount over the allowable limit. You'll pay this penalty when you file your taxes for the year, so if you can fix the excess contribution before then, you should do so.

What Is My MAGI?

Your modified adjusted gross income is the number the IRS uses to determine your eligibility for annual contributions to a Roth IRA. The MAGI is determined by adding certain deductions back to your adjusted gross income. If you are uncertain about what your MAGI will be for the year, be conservative with your contributions until you do your taxes to avoid excess contributions.

How Old Do I Need to Be to Make Catch-up Contributions?

You must be 50 years old at the end of the calendar year that you'll pay taxes for to qualify for a catch-up contribution. For example, you must be 50 by the end of 2023 to contribute $7,500 to your IRA or Roth IRA for the 2023 tax year. The amount increases in 2024 to $7,000 and $8,000 for people 50 and over.

The Bottom Line

You can avoid excess contributions by paying attention to your earned income, modified adjusted gross income, and annual contribution limits. Also, keep track of any contributions you’ve already made for the tax year—and be sure you allocate any contributions made between Jan. 1 and the tax filing deadline to the correct year. Finally, if you make a mistake, act quickly to fix it so you can limit the penalties you’ll owe.