A. This is an error many people made without knowing it first until later which could lead to a tax nightmare.
What is an excess IRA contribution?
Any IRA contribution that exceeds the limit that a taxpayer could contribute to an IRA for the year.
- IRA contributions that exceed the maximum annual dollar limit ($5,500 if you are under age 50 for 2017)
- Ineligible rollovers (e.g. sold your house and put the funds into your traditional IRA account)
- Rollovers after 60-day window has closed
What is the penalty for excess contribution?
Excess contributions are subject to 6% penalty each year until it is fixed.
How to fix excess contribution?
The only way to fix the problem and avoid the penalty is to withdraw the excess amount, plus or minus the net income attributable to it, by Oct 15 of the year after the year for which the contribution was made.
If you found this error after the deadline, you have to alert the IRA custodian that you are making an excess IRA contribution withdrawal, so they will issue the 1099-R with the correct coding for tax returning filing. Excess traditional IRA contribution withdrawal after the deadline is fully taxable. Excess Roth IRA contribution withdrawn after the deadline is not taxable because it's already after-tax money.
Let's say you made an excess IRA contribution for 2016 in April 2017, you have until Oct 16, 2017 (Oct 15, 2017 is a Sunday) to fix it to avoid the penalty. If the excess is not fixed by the deadline, the penalty applies each year that the amount is in the account, as of Dec 31, until it is fixed.
The penalty is paid by filing IRS Form 5329, which can be filed with your tax return or as a stand alone return.
Because the complexity related to excess IRA contributions, it's best for you to find a license CPA to deal with it. This blogpost's purpose is to make you be aware of this potential problem.