Key Points
- October 17, 2022 is the deadline to correct excess IRA contributions or change the tax treatment of your IRA contributions.
- There is a 6% penalty tax per year for each year the excess amount remains in the Self-Directed IRA.
- To correct an excess contribution, you can either withdraw, recharacterize, or carry it forward.
What does October 17 mean to you? In the financial industry, it is the last day to make changes to the tax treatment of your Self-Directed IRA contributions for the previous year.
If you accidentally made an excess IRA contribution or see a way to be more tax-efficient, there is still time! This year, since the typical October 15 deadline falls on a Saturday, the deadline is October 17, 2022 (the next business day).
Let’s explore more about Self-Directed IRA contributions and how to correct excess IRA contributions by the deadline.
What are the 2022 Self-Directed IRA Contribution Limits?
For 2022, the IRS tax law places an annual IRA contribution limit of $6,000 or $7,000 if you are at least age 50.
| Younger Than Age 50 | Older Than Age 50 | |
| 2022 IRA Contribution Limit | $6,000* | $7,000 (including the $1,000 catch-up contribution)* |
When Does a Self-Directed IRA Excess Contribution Occur?
What Happens If I Exceed Self-Directed IRA Contributions?
If you contribute too much to your Self-Directed IRA, it must be corrected by October 17, 2022. If your excess contribution is not corrected in time, the IRS will charge a 6% penalty tax per year for each year the excess amount remains in the Self-Directed IRA.
Note: If you contributed to both a Traditional IRA and Roth IRA in the same tax year and the total contribution was more than the allowed amount, IRS regulations require the excess to be removed from the Roth IRA first.
How To Correct Excess Self-Directed IRA Contributions
A few options to adjust your excess 2021 IRA contributions include withdrawal, recharacterization, or carrying it forward.
Withdraw
You are responsible to withdraw the following by the tax filing deadline (including any extensions):
- The excess contributions from your IRA
- Any income earned or lost that resulted from the excess contribution
There is no tax on the excess contribution removed, but the earnings withdrawn should be included in your taxable income. In addition, if you are under age 59 ½, the earnings distributed are subject to the 10% early withdrawal penalty. If the excess contribution is removed after you file your taxes, you may need to file an amended tax return.
For more information, please refer to IRS Publication 590-A.
Recharacterize
Recharacterization is when IRA contributions are moved from the current IRA to another type of IRA (Traditional IRA to Roth IRA or vice versa) in a reportable nontaxable transfer.
The contribution is treated as if it was originally made to the Self-Directed IRA it is recharacterized to. The earnings or losses attributable to the contribution being recharacterized are calculated using the IRS’s Net Income Attributable (NIA) formula below.
Carry Forward
The last option to correct your excess IRA contribution is to offset the excess by limiting your annual contribution the following year. No distribution from your IRA occurs.
For example, assume your contribution limit is $6,000 and you accidentally contributed $7,000 ($1,000 excess). You can offset the excess by limiting your contributions to $5,000 the following year. You will file IRS Form 5329 and pay the 6% tax penalty ($60) because the excess is not corrected by the deadline, but no tax is owed on earnings.
How To Calculate Earnings or Losses Applicable to Self-Directed IRA Excess Contributions
The IRS created a specific formula – Net Income Attributable (NIA) - to calculate earnings or losses attributable to an excess contribution.
Net Income = Contribution Excess x [(Adjusted Closing Balance – Adjusted Opening Balance) ÷ Adjusted Opening Balance]
Adjusted Opening Balance (AOB) – The prior month’s IRA value plus all contributions (including the excess contribution), recharacterizations, or transfers into the account since the excess contribution occurred.
Adjusted Closing Balance (ACB) – The current value of the Self-Directed IRA minus all distributions, recharacterizations, or transfers since the excess contribution occurred.
Examples Calculating Earnings or Losses Applicable to Self-Directed IRA Excess Contributions
Removing Excess Contribution Plus Earnings
Last year Carrie, age 35, contributed $7,000 to her IRA. When filing her taxes, she discovered that she is only eligible to contribute $6,000 and decides to remove the $1,000 excess. Before the contribution, her IRA balance was $20,000 and it is now worth $29,000. She did not make any additional contributions or distributions. Her AOB is $27,000 (20,000 + 7,000) and her ACB is $29,000.
Carrie will withdraw 1,074.07 ($1000 excess contribution + 74.07 earnings attributable to the excess contribution).
$1,000 x [($29,000-$27,000) ÷ $27,000] = $1000 x $2000 ÷ $27,000 = 74.07
NIA = $74.07 earnings
Removing Excess Contribution Minus Earnings
Last year Tony, age 65, contributed $7,000 to his Roth IRA. When filing taxes, he learned that he was only eligible to contribute $4,300 due to his amount of earned income. He will remove the $2,700 excess. His IRA balance prior to the contribution is $275,000 and it is now worth $260,500. He made no additional contributions or distributions. His AOB is $282,000 ($275,000 + $7,000) and ACB is 260,500.
Tony will remove 2,494.15 ($2,700 excess contribution - $205.85 loss attributable to the excess contribution) from his IRA.
$2,700 x ($260,500 – $282,000) ÷ $282,000 = $2,700 x (-$21,500) ÷ $282,000 = -$205.85
NIA = -$205.85 loss
Conclusion: Let’s Put It All Together
When it comes to personal finance, you want to get it right. Tax preparation and retirement planning have several important rules to keep in mind, including contribution limits and deadlines. If you accidentally contribute more than the IRS allows, which is more common than you may believe, do not fret! Speak with a financial advisor to decide the best way to correct it. This way, you can get back on track to reach your retirement goals.
Do you have questions about Self-Directed IRA contributions or another rule? Don’t worry, we have answers! Schedule a call with a Madison Trust Specialist today.
Disclaimer: All the information on our website is a general discussion for informational purposes only. Madison Trust Company does not provide legal, tax or investment advice. Prior to making any investment decisions, please consult with the appropriate legal, tax, and investment professionals for advice.
