If your IRA’s gotten too plump to please Uncle Sam, don’t fear. Removal of excess contributions (ROE) can help, if you respect deadlines and calculate the net income attributable (NIA).
Congratulations! You’re a conscientious saver with an eye on a comfortable retirement, and you regularly maximize your annual Individual Retirement Account (IRA) contributions. Then one day your tax advisor says, “Uh-oh, your IRA contribution isn’t a great idea this year.”
Say what? The reality is, there are a number of scenarios that could lead to this moment of truth: that you’ve got too much of a good thing. Luckily, the Internal Revenue Service has provided a mechanism to straighten things out. It’s called removal of excess contributions, or ROE, and it may help you right your unintentional wrong.
The best news is that ROE is nearly as straightforward as it sounds, although there are a few things you need to know.
First, consider timing. To avoid a 6% penalty on the excess and its earnings, both must be removed from your account by your tax-filing deadline for the year the contribution was made. This is usually April 15 of the following calendar year. Remember, this year the 2016 tax deadline is April 18, 2017.
If you file your taxes on time, you’ll normally qualify for an automatic six-month extension to October 15. However, procrastination doesn’t typically pay. Waiting until October 15 generally means filing an amended tax return, and the IRS can penalize you for each year the excess remains uncorrected.
Now, although you can avoid the 6% penalty with a timely removal of your excess, if you’re under 59½ and made money on your investments, you’re still on the hook for a 10% early withdrawal penalty on the earnings.
The next important consideration is determining how much you need to remove. This may not sound too tricky, but tax law isn’t known for its simplicity. To determine how much you’ll need to trim in earnings, you (or your IRA custodian, or a trusted tax advisor) need to calculate the net income attributable (NIA).
The concept itself is easy, although in practice this can get a little hairy. Rather than looking at your excess simply as the amount you contributed in the first place, the IRS views it as a percentage of your entire IRA. For example, if your $5,500 contribution was 5% of your account balance on the day it was made, you have to take out 5% of the current account balance to ensure that any gains (or losses) in your account that attributed to the extra contribution in question are also removed proportionally.
This is an update of a previously published article IRA Oops Moment? Here's Your Penalty Fix published on March 16, 2015.
Do you learn best by watching? Here's a short video to help you identify, understand, and correctly report a wash sale to the IRS.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, and a subsidiary of TD Ameritrade Holding Corporation. TD Ameritrade Holding Corporation is a wholly owned subsidiary of the Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 Charles Schwab & Co., Inc. Member SIPC.