Here’s What Happens If You Go Over the Limit for Retirement Contributions

Here’s What Happens If You Go Over the Limit for Retirement Contributions

Here’s What Happens If You Go Over the Limit for Retirement ContributionsWhen you first start saving for retirement, you might think you’ll never get to the point where you can “max out” your annual contribution. But perhaps your income has leveled up significantly since then, or you’ve prioritized saving for retirement. You might see yourself approaching that annual $19,500 limit for your 401(k) or $6,000 for your IRAs.

May as well throw in a little more, right? Not so fast. Saving for retirement is sort of like playing The Price is Right: You want to get as close as possible without going over.

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Want to know what happens if you do? (Here’s a hint: You’re going to lose some of that money.)

First, exceeding your contribution limits for retirement accounts doesn’t usually happen. If you have one retirement account, your risk of exceeding the limit is very low, since the firm that manages your plan will keep an eye on your contributions for the year. But if your finances are more complicated—perhaps you have a few different retirement accounts—you may need to pay more attention.

“The biggest cause of this is when the taxpayer switches jobs during the year and essentially has two retirement accounts that are not being monitored to the annual limit,” said Mike Savage, CPA and founder of 1-800Accountant. “If they only have one retirement account, usually the financial institution will make [them] aware of the excess contribution,” he said.

Another way you can get stuck in this situation is when you hit an income limit for your retirement account, like a Roth IRA. Maybe you fully funded your Roth for the year, but were also eligible for an employer-sponsored plan. “Most people that end up with an excess do so because it’s hard to measure where the income will be at the end of the year,” said Amin Dabit, director of advisory service at Personal Capital.

If you go over the limit for your retirement account, the IRS is not going to let you skate by unnoticed. You need to remove the excess from your account as soon as possible, or you’ll pay an excise tax penalty of 6%.

If you can remove the excess contribution before you file your taxes, you won’t have to pay the 6% penalty. You will, however, have to report it as income (which means it will be taxed) and you’ll probably have to pay a 10% penalty for early withdrawal from your retirement account.

You might be tempted to just leave the money there and take a 6% penalty over a 10% one. But it doesn’t actually work that way—that 6% doesn’t go away if you don’t make amends. “The IRS will impose a 6% IRS excise tax penalty for every year that amount remains in the account,” Dabit explained.

If your retirement account is through your employer, you’ll have to ask them to pay back the “excess deferral” to you, including any earnings on it, said Caleb Silver, editor in chief of Investopedia. If you’ve already received a W2 from your company, they’ll need to then provide an amended one.

You can also file an amended tax return; you can avoid the penalty if you remove the excess and refile by the October extension deadline.

“Pay attention to your earned income, modified adjusted gross income, and the annual contribution limits,” Silver said. “Keep track of any contributions you’ve already made for the tax year, and be sure you allocate to the correct year any contributions you make between January 1 and April 15.”

If you think the upcoming year is going to be unusually robust—maybe you’re expecting a raise or a bonus you want to put toward retirement—you can contribute toward last year’s limit now to avoid an issue after your income (and your contribution) increases. “One of the best ways to avoid contributing too much is to discuss with a tax advisor and look to make a contribution for the previous year at the same time you file taxes,” Dabit advised.

Source:- lifehacker

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