Additional IRA Contributions and Correcting Penalties
Many people have made contributions to their retirement accounts for 2017. If you are one of those people, consider using this time of year to make sure it was not in excess of an allowable contribution.
IRA Contribution Limits
The contribution limits for individuals under the age of 50 is $5,500 for 2017. For those over the age of 50, contributions cannot exceed $6,500 for 2017. An excess IRA contribution could occur if you or your spouse contributed to an IRA and did not have taxable compensation from an employer or self-employment income.
When it comes to Roth IRA, there are income limits for contributions. The income phase-out range in 2017 is between $117,000 and $132,000 for single filers. For those married-filing jointly, the income phase-out range is between $184,000 and $194,000. If your income is above the phase-out range, your contribution will be considered in excess of what is allowable. When it comes to traditional IRA contributions, income is not considered; however, age limits will apply. There are no allowable contributions to a traditional IRA for individuals age 70 ½ and above.
Penalty for Excess Contributions
There are penalties associated with excess contributions if they are not corrected by a certain deadline. For every year that the excess contribution remains in the IRA, a 6% per year penalty will be applied. This will result in a compounding problem if not corrected as soon as possible.
How to Correct Excess Contributions
The deadline correcting an excess contribution for 2017 October 15, 2018. If corrected by that date, the 6% penalty can be avoided. There are a couple of strategies in which that penalty may potentially be avoided.
One strategy would be to withdraw the contribution in addition to any earnings or loss from the account. If there are any earnings, they will be considered taxable and could potentially be subject to tax in addition to the 10% early distribution penalty if that individual is under age 59 ½. The contribution, however, will not be considered taxable or subject to the early withdrawal penalty.
The other strategy would be to re-characterize the actual contribution in addition to any earnings or loss that occurred in the account. One would directly transfer the contribution and earnings or loss into another type of IRA, such as a Roth into a Traditional. This would not be considered taxable or subject to the early withdrawal penalty.
The strategy that best suits one’s needs will likely depend on that particular situation. For someone who mistakenly made an excess contribution into a traditional IRA but is above 70 ½, you might consider a re-characterization into a Roth IRA as there are no age limits. If this excess contribution occurred because of the lack of taxable compensation, then one would need to make the correction by taking a withdrawal in which gains might be considered taxable.
Tax season is a convenient time to correct any excess contributions for 2017 and avoid missing the deadline in October. This will make certain that the deadline is not missed and no penalties are incurred. This will also allow an individual to avoid having to file an amended return once the correction has taken place.
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