Excess IRA Contributions

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Question or Topic

The Question: What do I do if too much was deposited in my IRA or Roth IRA?

Objectives

Cure the excess contribution and reduce any penalties

IRA Contribution Limits

IRA Contributions and the 2001 Tax Act

Saver's Credit

IRA Preservation Planning (PowerPoint)

Take Control with IRA Preservation Planning

	The Answer

If you are reading this one shall assume you have already incurred or know someone who has contributed too much to an IRA. Please read the related articles listed above for more information about the limits of IRA contributions.

The objective herein is to cure the excess contribution with the least cost in penalties.

We shall cover the three points at which the excess can be removed:

Before the personal tax return is filed
After the personal tax return is filed - or
Leave the excess in the IRA and carry over the excess to the following year as and adjustment to the following year.

See the solutions sections below (scroll down) for instructions on how to accomplish the task. First - consider the following:

All methods will incur some form of "penalty". Using some of the methods, the penalty is based upon only the income from the excess contribution while others will base the computation upon the amount of the excess contribution. One should make computations to determine which method is:

the least costly,
the most convenient
the most advantageous considering all other circumstances of the event.

	Solutions

Solutions are dependent upon facts & circumstances, law and the objectives. These elements vary from one time to another, from one circumstance to another and from person or entity to another.

Kit to Prepare for Your Adviser

IRA Preservation Fact Finder

Excess Contributions – Client Kit (MS Word)

Excess Contributions – Client Kit (browser)

Three circumstances

Withdrawal by due date (including extensions) of the tax return
Withdrawal after due date (including extensions) of the tax return
Carry Over Excess to a subsequent year

The following chart will help to explain - compare and contrast the choices:

Circumstance	Treatment of Excess Contribution	Treatment of Income on the Excess Contribution	6% Excise Tax on Excess Contribution	10% Early Withdrawal Penalty
Withdrawal by due date of the tax return. §408(d)(4); §1.408-4(c)(2)(ii); §1.408-4(c)(2)(iii)	No Deduction and not included in income	Must be withdrawn, & included in income. If withdrawn after year end be certain to include in income in the year of the excess contribution	No Excise Tax	10% of the income apportioned to the excess contribution
Withdrawal after due date of the tax return. §408(d)(5)(A);	If no deduction was claimed do not include in income, otherwise include in income.	Income earned does not need to be withdrawn and included in income.	The 6% excise tax must be computed on the amount of the excess contribution until the amount is withdrawn (excluding the year of distribution)	No early distribution penalty
Carry over excess as contribution in following year(s).	No withdrawal – the allowable contribution in the following year(s) must be reduced by the excess contribution until it is consumed	No withdrawal – not included in income	6% excise tax is computed for each year the excess contribution remains in the IRA before it is consumed	No early withdrawal penalty

The taxpayer has the right to choose the method. However, if discovered too late one or more of the alternatives may not be available. Therefore, early discovery is important.

One should make computations to determine which available method produces the least cost. For example, if the tax inclusion of the earnings withdrawn produces little income tax and the 10% early withdrawal on that income produces little cost, then the withdrawal before the tax return due date may be the best choice. On the other hand if the 6% excise tax produces little cost, then one of the other methods may produce the least cost. It will be different for each circumstance and one should make all the computations (including the consideration of market fluctuations, and the tax-deferred or tax-free compounding of the earnings). The following will help to identity other issues or circumstances to consider - keeping in mind your personal circumstances may be different or include others:

Convenience of obtaining IRA owner signature
Convenience of obtaining a signature guarantee
Transaction fees
Early redemption fees

Withdrawal by due date (including extensions) of the tax return

If you have time to withdraw the excess by the due date, including extensions, of the taxpayer's tax return - then do not deduct the excess, do not include in income, do not compute the 6% excise tax. All income attributable to the excess must be withdrawn, included in income and the early withdrawal must be computed.

If the withdrawal occurs in the year following the contribution the income attributable to the excess must be included in the prior year. There will be no 1099-R for the year which must include the income attributable to the excess. The 1099-R for the year following the excess contribution will indicate the amount of the withdrawal and the year in which the earnings must be included (the year of the excess contribution). IF the income is not included on the tax return for the year of the excess contribution - amend the return.

Withdrawal after due date

Do not take a deduction for the excess. Usually this is not an issue. However, you may have experienced special circumstances that placed you into a position of complying the the maximum contribution, but for which you were limited to a lesser amount. In the case you deducted too much, then you must include the drawing of the excess in your income. The income attributable to the excess need not be withdrawn and included in gross income. The 6% excise is imposed for each year the excess contribution remains in the IRA excluding the year of the distribution.

Using the excess as a following year contribution

The excess may be treated as a deductible IRA contribution in a year following the year of the excess contribution. The 6% excise tax will be imposed for each year the excess contribution remains in the IRA before it is covered by this exception.

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