What To Do When You Over-Contribute to an IRA

Contributing to an IRA can be a great way to increase retirement savings, due to the special tax advantages these accounts offer. But the IRS isn’t prone to offering free-for-alls; IRAs have limits for how much an individual can contribute during a given calendar year. Current contribution limits for the maximum total contributions to Traditional and Roth IRAs are limited to the lesser of: $6,000 ($7,000 if you’re age 50 or older), or your taxable compensation for the year. Note that this limit is subject to change every year, so for future years, the limit could be higher, lower, or the same as today’s contribution limit.

So, what happens if you contribute in excess of the IRA contribution limit for the year?

Well—for starters, IRA providers, like Betterment, usually have systems in place to help you prevent over-contributing.

However, for various reasons, an individual may over-contribute to an IRA in any given year. The most common situation occurs when an investor has IRA accounts at multiple providers. For instance, if you’re trying Betterment for the first time, you might have one IRA in an online brokerage account that you manage yourself and another IRA with Betterment that you began mid-year. Because you’re working with two different companies, it’s not uncommon to unintentionally over-contribute.

Luckily, there are a few methods that can be used to correct this.

Methods to Correct Excess Contributions

There are four main methods for correcting an excess contribution. The first two can be done prior to the tax filing deadline, and latter two can only be completed after the tax deadline has passed.

1. Remove excess contributions prior to the tax filing deadline.

If you remove the excess contribution plus the net gain or loss prior to the tax filing deadline, you will not owe taxes on the excess contribution itself, but you will owe ordinary income tax, and if you’re under the age of 59 ½, you’ll owe the 10% early distribution penalty on the earnings. If you remove the amount after filing your taxes, but prior to the deadline mentioned above, you typically need to go back and amend your return.

You can remove excess contributions from your IRA via Transfer or rollover > Withdraw > (type of) IRA. Remember to mark the withdrawal as a "Removal of Excess 2022 Contribution." Our system will automatically calculate the earnings on the excess contribution that you will need to remove.

Because the IRS requires Betterment to report all IRA contributions, even those withdrawn as excess, if you remove excess contributions from an IRA for a given tax year, you can no longer re-contribute that amount for the same tax year.

2. Recharacterize your IRA contribution.

Recharacterizing an IRA contribution is the process of transferring the excess contribution from a Roth IRA to a Traditional IRA or vice-versa, depending on your situation. The caveat here is that you cannot recharacterize more than the allowable maximum contribution. When you recharacterize, the contribution is deemed to have happened in the same tax year as the original contribution. You will still need to calculate the net gain or loss associated with the amount being recharacterized, and this amount will need to be recharacterized as well. Generally, there is no tax associated with a recharacterization.

Most recharacterizations from a Roth IRA to a Traditional IRA can be done automatically in your account. To see if your Roth to Traditional IRA recharacterization is able to be done automatically, please first login on a web browser.

You will need to have an open Traditional IRA to receive the recharacterized funds. If you do not have a Traditional IRA open already, please open one by selecting Add new + > Plan for retirement > Add new account to retirement goal > Traditional IRA, and complete the flow.

Once you have a Traditional IRA set up, go to Transfers > New Transfer > Other ways to transfer > IRA Recharacterization.

If you are unable to complete your recharacterization automatically for any reason, please send an email to support@betterment.com so that our customer support team can assist you.

3. Remove excess contributions after the tax filing deadline.

If you are removing the excess contribution after the tax filing deadline, you will be subject to a 6% excise tax for each year the excess contribution stays in the account. You do not need to calculate the earnings attributed to the excess contribution as you only remove the contribution itself.

To remove contributions from prior years, you can make a distribution from your IRA by choosing Transfer or Rollover > Withdraw and selecting the “Early distribution” or “Normal distribution” option from the dropdown.

Please note that you may be subject to excise taxes for leaving the excess IRA contribution in your account after filing your tax return for that year.

4. Carry forward your contribution.

You can offset the excess contribution by reducing your contribution for the ensuing tax year, assuming you qualify to make a contribution in that year. You can calculate how much to reduce the ensuing years contribution by taking the maximum less the excess amount. With this method, there will not be any type of distribution from the IRA. Even though there is not a distribution, you will be subject to the 6% excise tax on the excess amount.

Other Interesting Points

  • If you contribute to both a Traditional and Roth IRA, the excess amount would be considered the Roth IRA.
  • If you make contributions throughout the year, the most recent contributions will be considered the excess.

You can learn more of the details on IRA contribution rules straight from the IRS by reading this article.

Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a tax professional.