The cost of not tracking your IRA contributions

Do you know how much you’re allowed to contribute to your IRA each year? Are you periodically tracking your deposits? Contributing more than the permitted amount can result in costly penalties. Fortunately, there are ways to fix it.

How can it happen? 

Let’s look at a hypothetical example. In 2016, Ahmad, age 51, set up monthly automatic bank deposits to his traditional IRA that totaled $8,500. However, the IRA contribution limit for 2016 is $5,500, with a catch-up contribution for individuals over 50 of $1,000, for a total of $6,500.

Although we believe automatic deposits are the best way to invest for your goals, it’s also an easy way to unintentionally contribute too much to your IRA. You may also end up with an excess contribution if you contribute to a Roth IRA and later discover that your modified adjusted gross income (MAGI) was above the Roth IRA income limit. And because you’re not allowed to deposit money into a traditional IRA for the year you turn 70½ or later, forgetting to turn off automatic deposits or continuing to contribute past that age will also count as excess contributions. Roth IRAs have no age limits for contributions.

What can you do?

When Ahmad realized his mistake in January 2017, he withdrew the excess contributions ($2,000) and their associated earnings before his tax-filing deadline (this year, that’s April 18, 2017). Like Ahmad, if you discover the error before you file your tax return, you have until your tax-filing deadline – usually April 15 – to withdraw the excess contributions plus net earnings.

The key is to discover your mistake before you file your tax return. If you discover it after you file your return, there will be penalties.

What if you don’t discover the excess until after you’ve filed your tax return?

If you don’t discover your mistake until after you’ve filed your tax return, you can either remove the excess within 6 months and file an amended return by October 15 or carry forward the excess contribution amount to next year’s contributions.

If you decide to carry forward the excess, be aware that you cannot carry forward the earnings attributed to the excess amount. You must withdraw them and, if you’re under 59½, pay an early withdrawal penalty. Earnings are taxed as ordinary income. You will pay a 6% annual penalty until the excess is corrected.

It’s important to note that any excess contributions removed from your Roth IRA after your tax filing deadline are treated as regular Roth IRA distributions. This means that the excess amount is tax-free and not subject to the 10% early withdrawal penalty. However, the 6% annual penalty until the excess is corrected will still apply.

Whose responsibility is it anyway?

It is your responsibility to review your contributions and to make sure you contribute what is permitted. Although custodians may alert clients who make excess contributions into their traditional or Roth IRAs, it isn’t always easy for a custodian (or your advisor) to recognize excess contributions. Only you will know your year-end MAGI, which affects your eligibility for a Roth. SEP and SIMPLE IRAs may also be affected by your income level.

Although this discussion has revolved around traditional and Roth IRAs, you must also pay careful attention to the contribution limits for SEP and SIMPLE IRAs. It is the employer’s responsibility to ensure that an employee’s salary deferrals as well as company contributions are deposited properly. Be aware that additional steps may be required to correct contribution mistakes made to SEP or SIMPLE IRAs.

What are the 2016/2017 IRA contribution limits?

So far we’ve focused on the problem of contributing too much to an IRA. However, if you can afford to, make sure to maximize your retirement contributions. As a quick review, for traditional and Roth IRAs the limit for 2016 or 2017 contributions is $5,500 or 100% of your earned income (whichever is less), with an additional “catch-up” limit of $1,000 for people age 50 and over. Please check this chart on our website for more details, as the limits are different for the many kinds of retirement accounts available.

As we approach the deadline to contribute to your retirement for 2016, make sure that you’re aware of the contribution limits, review the deposits you’ve already made into your IRA account(s), and promptly take care of any excess contributions. Saving for retirement is hard enough without having to pay penalties for avoidable mistakes.

We strongly advise you to consult with your tax advisor about how to report or handle any excess contributions.

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