Act fast and the damage should be minimal
Dear Dan,
Due to a missing form, I had to file for an extension on my tax return. My understanding was that gave me until Oct. 15 to file but if I was going to do a 2023 IRA contribution, it needed to be made by April 15. I did that, but messed up in that I thought the maximum contribution was $8,000 (I’m 52) but it was only $7,500 for 2023. (The max is $8,000 for 2024.) What do I do about this?
—Overfunded
Dear Overfunded,
You have made an excess contribution but fixing this in a timely manner will keep it from being an issue. Larger excess contributions uncorrected for long periods can be expensive.
The penalty for making an excess contribution is 6% per year for each year the excess amounts remain in an IRA. That can add up over time but ultimately tops out at 6% of the combined value of all your IRAs as of the end of the tax year. The same rules apply to excess contributions made to a Roth IRA.
Excess contributions come in three forms. The most common are an improper rollover and what you did, contributing more than the annual limit. The least common form of excess contribution are contributions to traditional IRAs by taxpayers age 70 ½ in 2019 or earlier. While taxpayers in that age range have always been able to contribute to Roth IRAs if they meet other requirements, only since 2020 have they been able to make contributions to traditional IRAs.
I’m a little surprised this wasn’t caught before the deposit was made. Prior to April 15, one can make a contribution for the prior tax year and/or for the current year. As a result, most companies offering IRAs provide some information about limits in the documentation that goes with the paperwork indicating for which tax year the IRA contribution is being made.
The good news for you is that you have time to avoid the 6% tax. Avoiding the tax is possible if the correction is made prior to the due date of your individual income tax return including extensions. You said you filed for an extension, so you have until Oct. 15.
If you plan to fund the account for tax year 2024, the simplest thing to do is have the custodian (financial institution holding the IRA account) recode $500 of the deposit as a 2024 contribution. Otherwise, to make the correction, you must withdraw the excess contributions from your IRA and any earnings on the excess contribution. The earnings will be taxable income. The financial institution holding the account should have a form you can fill out to get that done.
If you do not deal with the excess contribution by your filing deadline, the 6% tax comes into play. You will need to process the custodial forms to remove the excess contribution and earnings on that contribution. You may also need to amend your 2023 tax return to reflect the correction. Your tax adviser should help you with these forms.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.