Saving for the retirement is a good way to secure your financial future. Actually if you are reading this post you are in better position than the average American.
Roth IRA is an ideal retirement tool if your household income is less than the IRS contribution limit (193K for if you are filing jointly, or 110K if you are filing individually). The reason is that the investment gain are not subject to tax after you retire.
How does the over contribution happen?
Many people maximize their contribution ($5500 for 2015 and 2016) each year according to their normal income level. However, things could change that makes you not eligible for the full amount contribution. Such as a sudden increase in your income (bonus, stock gain, etc). This is a change in good way, but IRS doesn’t like it. If not handled properly, you are subject to fines and penalties.
People typically find these things out during the tax season. Fortunately, you can do something before the tax filing deadline (April 18, 2016 for tax year 2015).
Three ways handle the over contribution
1. Recharacterize the over contribution into Traditional IRA
Re-characterize to traditional IRA is the best option in my mind. Because it doesn’t incur penalty and you are still saving for your future. If your Roth IRA and Traditional IRA are in the same financial firm, you can literally do it in minutes.
If you don’t have a Traditional IRA account already, don’t worry. Opening one is typically painless if you already have an retirement account (like your Roth IRA) opened. Take the Fidelity as an example, just click the “Open an Account” on the top of the webpage.
Once the Traditional IRA account is in place, call up the customer service or find the “recharacterize IRA” in their resource pages. Again, use Fidelity as an example, you can go to the “Customer Service” at the top of the page, then find the “forms”, the “recharacterize IRA contribution” is among the “most popular forms”. If you call their customer service they will guide through the process to find it.
2. Contribute to future year IRA savings
If you can not recharacterize the over contribution to Traditional IRA (the Roth and Traditional IRA share the same $5500 yearly limit). Then the next best option is to apply the contribution to future year. You would need to pay 6% penalty to IRS each year until it become legible contribution.
3. Withdraw the excessive contribution
Another way to handle it is to withdraw it from the Roth IRA altogether. I rank it last because if you are 59.5 years or younger, you would need to pay 10% early withdraw penalty.
I handled the over contribution, now what?
After you removed the excessive contribution from your Roth IRA, all you need to do is to update the Roth IRA contribution level in your tax preparation software or inform your CPA. For example, if you removed $1000 from the $5500 contribution, just update your contribution to $4500. That’s it.
Hope it helped you and enjoy be prosperous.