What Happens If Someone Puts Too Much Money in Their Roth IRA?
Sometimes, people are eager to save for retirement and may end up contributing too much money to their Roth IRA account. When too much money is put into this account in a given year, it can trigger tax penalties. Luckily, there are ways to go about resolving this problem and potentially avoiding the penalties they just imposed on themselves. People may carry on reading to find out everything they need to know regarding the aforementioned.
Why Would Someone Overcontribute?
Many reasons exist as to why someone would contribute too much money into a Roth IRA, for example:
They Earned Too Little Income
Over-funding of your Roth IRA occurs when someone earns less for a given year than originally expected. Similar to traditional IRAs, Roth IRAs are funded with taxable compensation. In other words, it is funded with money earned from working and not investment income.
To put the above into perspective, if at the beginning of a given year a person made a full Roth IRA contribution, but didn’t end up earning that much, then part of that contribution is considered excessive.
Annual contribution limits that apply to individuals younger than 50, wanting to contribute to a Roth IRA account is $6,000 as of the year 2022. Those 50 years or older can contribute a total of $7,000, as the additional $1,000 is considered a catch-up contribution.
They Earned Too Much Income
Another reason could be with regards to the fact that someone earned more than expected but have already maxed out their Roth IRA in that given year. The law regarding Roth IRAs sets income limits on a person’s eligibility for contributions to this account, and if a person is eligible, there is also a law surrounding how much they can contribute.
To help get a better understanding, if someone files their income taxes individually, they are not able to contribute towards a Roth IRA account if their modified adjusted gross income exceeds $144,000 in 2022. They are eligible for partial contributions of an amount ranging anywhere between $129,000 and $144,000. Any amount below $129,000 makes them eligible to contribute up to the limit.
In the case of those who earn well within these limits, there is no cause for concern. However, if a person just about borders these limits, then it is important to know that a bonus or even a pay raise can push this person over them, resulting in an excess contribution.
How to Handle Excess Roth IRA Contributions
Below are just a few remedies to choose from if someone ever finds themselves having contributed too much to their Roth IRA account. A crucial part in avoiding penalties, however, is to make sure action is taken before any tax-filing deadline is met. Currently, a 6% tax penalty exists for those who have contributed excessively.
Excess Contribution Withdrawal
A person can avoid the penalty by simply withdrawing any excess contributions and the money they have earned in the meantime before the due date of their tax return. Any earnings portion that they withdraw will, however, be included in their taxable income for that year.
Excess Contributions Recharacterization
Another solution is to recharacterize any excess Roth IRA contributions made by moving them into a traditional IRA instead. This is done through an instruction to the financial institution holding a person’s Roth IRA to transfer the excess amount and its accompanying income into a traditional IRA. This traditional IRA can either be at a different financial institution or the same one.
If this is completed before any tax return due date, a person can effectively ignore the contribution to the first IRA by treating the contribution as made to a second IRA for that year.
Forward Your Excess Contributions
Last but not least, a person can apply excess contributions and earnings to the next year’s Roth IRA, as long as the limits within that year are adhered to.
The End Result
While many reasons exist as to why someone would contribute in excess to their Roth IRA, there are an equal number of solutions that exist to resolve this problem and hopefully avoid any tax penalties that result as a consequence of the aforementioned. For any questions or concerns, consult an experienced Pittsburgh PA financial advisor immediately. They can help address inquiries regarding taxes and finances, including understanding what is the 5-year rule for Roth IRA.
This material was prepared for The Kelley Financial Group.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax, legal, or investment related advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.