Correcting Roth IRA Contribution Mistakes

I wrote awhile back about how to undo Roth IRA conribution mistakes, and a reader named Mike recently left an insightful comment on that post. It seems that Mike is in the unfortunate position of having contributed the full amount to his Roth IRA, but year-end bonuses pushed him above the eligibility threshold. He’s now spent hours online as well as talking to the IRS and tax specialists, and he wanted to shared what he’s learned.

In short, Mike writes that there are two options for “undoing” excess Roth IRA contributions:

1.) Recharacterizing the contributions to a Traditional IRA. As stated in the original post, the excess contributions and any associated earnings are directly transferred to a Traditional IRA. Everything is subsequently treated as if you had originally made the contributions directly to the Traditional IRA in the first place.

2.) Withdrawing the excess contributions along with any associated earnings. If this is done before a certain date in the calendar following the tax year of the excess contributions, then the 6% penalty is waived. The excess contributions themselves are therefore not taxed or penalized. HOWEVER, the earnings will be treated by the IRS as a non-qualified distribution and are subject to a 10% penalty (in addition to normal income tax). This fact was confirmed both by an IRS representative and by a tax specialist. [Note: I did mention this in my original post.]

To summarize, then, the IRS penalizes you for making excess contributions and then withdrawing them to correct the problem – even if you make the correction in a timely manner. There’s simply no way to get around the 10% penalty (unless you meet one of the qualified distribution requirements), no matter how “aware” you are of the situation.

Just something to keep in mind when deciding whether or not to contribute to a Roth IRA if you’re “on the bubble.” Truth be told, 10% of the earnings on your contribution won’t usually end up being a particularly large sum of money, but there’s also a major hassle factor involved Remember, you have until April 15th of the next year to make your contributions, so if you’re worried that you might break the threshold and don’t want to deal with undoing your contribution, you might want to set the money aside and wait until you’re confident that you’re in the clear before making your contribution.

17 Responses to “Correcting Roth IRA Contribution Mistakes”

  1. Satish: The income limits on Traditional IRA contributions have only to do with deductibility. Unlike a Roth IRA, you can contribute regardless of how much you earn, but you can only deduct it if you’re below the threshold.

  2. Anonymous


    Mike’s response as well as your original post mentions that one of the options for this problem is “Recharacterizing the contributions to a Traditional IRA” but there are income limits for Traditional IRA also. How will that work since if you are over the Roth IRA income limits, most likely, you are over the Traditional IRA income limits?

    Also, you said in your original article that if you re-characterize to traditional IRA, it won’t be tax deductible but it is tax deferred. Is it not tax deductible because you are over the traditional income limits?


  3. Anonymous

    I have over contributed in my Roth IRA in 2007. What is the best way for me to remove the excess
    contribution without getting any penalty (before tax due date). Should I use the IRS Form 5329 or have my Trustee remove the excess contributed and mail it to me? Thanks.

  4. Anonymous

    My wife and I opened a Roth IRA account in April of this year (2007) by mistake. We thought we could open it based on our income. The problem is all our income comes from my retirement, social security and interest. We put the max for 2006 of $5000 in each account just before the April 15th deadline then we put the max for 2007 of $5000 in each account after April 15th. I started filling out my income taxes for 2007 a couple of weeks ago and that’s when I discovered that we can’t set up a Roth account. We lost about 40% of I investment on some useless stocks. I was told by Ameritrade that I need to transfer all of the accounts to our joint brokerage account.
    I am wondering if I will be able to claim the losses we occured on the investments and what method would I use to show the IRS. Both roth accounts have been transferred back to our regular brokerage account by 12-31-07. Will we have a penalty since we lost money?

  5. Anonymous

    I have another question about excess contributions into a Roth IRA, to which I have not found a definite answer. I work for an organization in the U.S., who pay my salary, but I live overseas and therefore use the foreign earned income exclusion when filing taxes (leaving me no U.S. taxes to pay). My annual salary is below $45,000, and I have been contributing the maximum allowed to a Roth IRA for myself and my wife for about 10 years. However, I recently was told that I might not be eligible to contribute because I use the foreign earned income exclusion (possibly meaning I have no taxable compensation)and therefore must pay an excise of 6% for each year the contributions remained in the IRA, and that I must remove all the contributions and interest payed from the accounts. Before I make a big mistake, I wanted to see if this “advice” is correct. Can you give me some guidance?

  6. Anonymous

    Hello, I opened a SEP account in 2006. I mis understood and thought I could put a lot more money in it. I put in 20,000 but needed the money a week after I opened the account so I asked for a distribution. I realize now that I could have only contributed 4,000 to my SEP. Normally to do an excess contribution removal from the account the money still has to be in there. Is there anyway to reclassify my distribution? It happened before the tax filing deadline.

    I called the mutual fund company and they were not helpful.

  7. Anonymous

    What happens if you said you were going to make a contribution to your Roth IRA, and then you forgot? How do you fix it after the contribution date has passed?

  8. Anonymous

    All good information. Thank you. I’m in the situation of having reported a Roth contribution for tax year 2005 (I did my taxes in Jan and intended to contribute before April), but circumstances prevented it. Does anyone have advice for how to correct this scenario?

  9. Anonymous

    In reading pub 590, it states that you can apply excess contributions to a later year. From my readings, it looks like you can pay the 6% excise tax on the excess portion and leave the money in the account. That excess is then subtracted from what you’re allowed to contribute in the following year.

  10. tjs: You need to keep track, although this can get sticky. In the case of a mutual fund, you should know the number of shares you bought with your $3k excess contribution, the purchase and sale price, as well as the dividends that have been paid out per share (and on what dates). So that’s pretty straightforward. In the case of an interest-bearing vehicle, it’s probably a bit more difficult, especially if you’ve added money periodically over the year. In short, I guess you’d have to calculate the proportion of interest from each month (or whatever period) goes to your $3k principal (as well as interest on interest earned from that $3k, and so on, going forward). If the $4k is the only money in the account, then it’s going to be a lot easier, because the $3k excess contribution is simply 3/4 of the total (pull out 3/4 of the balance, and anything in excess of $3k is earnings).

  11. Anonymous

    Very helpful information, thanks. I do have the following question though: when withdrawing the excess contributions along with associated earnings, is there a general formula to determine the earnings that need to be withdrawn? For example, if $4,000 was contributed for the year and eventually $3,000 turned out to be in excess, how can we calculate the earnings attributed to the $3,000 excess amount?

  12. Anonymous

    I maxed my contribution for last year at the end of the year, and this year I am making regular contributions to about half of my allowed limit throughout the year. I am also making “contributions” for the other half to a savings account, which I will put into the roth at the end of the year to max out. I am nowhere near the bubble, but this way I don’t tie up money and do not need to worry about the hassle of taking money out should it be necessary. I don’t expect that it will be, though.

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