A Self-Directed IRA is a wonderful tool for saving for a secure retirement, and anyone who does not take advantage of them by contributing up to the allowable limits ($6,000 in 2019, $7,000 if you are age 50 or over) is wasting an opportunity and leaving gaps in their retirement funding. It should be every retirement saver’s goal to meet these annual limits each year. But what happens when someone exceeds them? Is there any way to correct it?
Well, it happens so many times that the IRS has a name for it: it’s called an excess contribution. And yes, it can be corrected. Here are the details:
How do excess contributions happen?
It seems simple enough. You are allowed to contribute $5,500 to a traditional or Roth IRA for the 2018 tax year, so you write a check for no more than that amount and send it to your Self-Directed IRA custodian. What could go wrong? Here are some of the ways people lose track:
- You have exceeded the IRA limit through multiple accounts:The annual limit on IRA contributions is the combined total of traditional and Roth IRAs, not each IRA. Add up all of your IRAs, both traditional and Roth, to make sure you have not contributed too much.
- You have got your Self-Directed IRA savings on autopilot: Also known as an automatic investment plan, you can have your monthly withdrawals taken from your checking account. If you have the amount set too high, you will go over the limit. For example, with the contribution limit at $6,000 for 2019, make sure your monthly investment does not exceed $500.
- Your income is too high for a full Roth IRA contribution: Unlike Traditional IRAs, Roth IRAs have income limits to determine who qualifies. Contributions are reduced or phased out at higher income levels.
- You have reached the age of 70 ½: Some people do not realize that contributions to a Traditional IRA are not allowed in and after the year they turn 70 ½. This rule does not apply to Roth IRAs or rollover contributions.
How do I fix things if I contribute too much?
If you have contributed too much to a Self-Directed IRA, it’s an easy fix if you do it before filing your taxes. Contact your IRA custodian and let them know you have an excess contribution. They will provide the appropriate paperwork.
Withdraw the excess contribution and any earnings from the Self-Directed IRA. Earnings are calculated through a formula called “net income attributable,” and they are taxable as ordinary income. You might need to contact a tax professional for help in calculating your earnings.
If you discovered your mistake after filing your taxes, you still have a few options:
Call your IRA custodian. If you remove the excess contribution and earnings and file an amended tax return by the October extension deadline, you can avoid a 6% penalty.
You may also carry the excess forward to the new tax year. For example, if you contributed $250 above the limit in 2018, you can count it toward your 2019 contribution. You will pay a 6% penalty while the excess contribution is on the books, but you will avoid any future penalties.
Another option, which is typically not recommended, is to do nothing and pay 6% on the excess every year. Some Self-Directed IRA holders reportedly over-contribute to their accounts intentionally, rationalizing that their investments will do better than the 6% penalty. But your accountant will likely warn you not to follow this risky path.