This week, Money Girl shows you 4 ways to avoid an expensive penalty if you contribute too much to an IRA. Plus, download a handy resource to see the differences between traditional and Roth retirement accounts.
Q. I have a Roth IRA, but my income this year will probably exceed the annual limit. What should I do if I already made contributions to the account?
A. Making too much money to be eligible to contribute to a Roth IRA is a terrific problem to have! It’s the only type of retirement account that shuts the door to making new contributions when you earn too much.
Here are the income limits for 2015:
- If you’re married and file taxes jointly, you’re ineligible to contribute to a Roth IRA when you make over $193,000. There’s also a “phase out” range that begins at $183,000, when you can contribute less than the allowable limit.
- If you’re a single taxpayer, the income cutoff for making Roth IRA contributions is $131,000, and the phase out range begins at $116,000.
If you earn less than these amounts, you’re eligible to max out a Roth IRA by contributing $5,500, or $6,500 if you’re over age 50.
These are the same contribution limits for a traditional IRA. You can even contribute to both a traditional and Roth IRA in the same year, as long as the your total contribution isn't more than the annual limit.
If you contribute too much to a traditional or Roth IRA, there's a 6% penalty every year that the contributions and their earnings remain in the account. So use one of these 4 options to fix your retirement account and avoid an expensive penalty:
IRA Fix #1: Make a Withdrawal Before Taxes Are Due
Contact your IRA custodian or administrator and ask for excess contributions to a traditional or Roth IRA, including any income they earned, to be withdrawn before your tax filing due date (typically April 15).
The contributions will be considered as never having been contributed; however, you will have to pay tax on their earnings, if applicable.
IRA Fix #2: Make a Withdrawal Within 6 Months After Taxes Are Due
If you file your taxes, but later realize that you contributed too much to a traditional or Roth IRA, you have an extra 6 months to correct it. But you must file an amended tax return.
IRA Fix #3: Apply the Excess to the Following Year
You can ask your IRA custodian to apply excess contributions to a traditional or Roth IRA to next year’s contribution, as long as they don’t exceed the maximum allowable limit for that year.
Also, for a Roth, consider the income limits for the following year and whether you think you’ll be eligible to contribute to one.
IRA Fix #4: Recharacterize the Excess to a Traditional IRA
You can transfer excess Roth IRA contributions to a traditional IRA through a process called recharacterization, as long as you haven’t already maxed out a traditional account.
Ask your IRA custodian to move the contributions, plus their earnings, to an existing or new traditional IRA. If you complete a recharacterization by October 15 of the following year, you’ll avoid any penalty.
Since traditional IRA contributions are made on a pre-tax basis, they reduce the amount of income tax you have to pay. So if you already filed taxes, be sure to submit an amended tax return after doing a characterization, in order to receive a tax refund.
Confused about the differences between traditional and Roth retirement accounts? Download Laura's Retirement Account Comparison Chart PDF and get clarity about IRAs and workplace retirement plans.
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