Contributing to a Roth IRA is an attractive option for clients of all different income levels—the tax-free income source can prove invaluable to many during retirement. Despite this, the IRS imposes strict income-based limitations that determine which clients are actually eligible to contribute to a Roth IRA in any given year.
For this reason, clients may find themselves in a position where they have contributed to a Roth, and later discovered that they were actually ineligible to make the contribution—whether because of higher-than-expected income levels or otherwise.
In these situations, it’s important to know that the client still has options available to correct the mistake—and potentially avoid imposition of steeper penalties in the future.
Roth Contribution Limits
A variety of reasons exists to explain why a client might make a Roth IRA contribution and later discover that he or she has violated the Roth contribution rules. First, in 2015, the ability to make contributions to a Roth IRA begins to phase out for married clients with modified adjusted gross income (MAGI) over $183,000 ($116,000 for single clients). Roth contributions are completely blocked for married clients who earn over $193,000 and single clients who earn over $131,000.
A client could easily expect that his or her income would fall below the applicable thresholds, make a Roth contribution early in the year and later discover that he or she earned more than expected, thereby becoming ineligible to contribute. Further, married taxpayers filing separate returns are almost always ineligible to contribute if MAGI exceeds only $10,000—a rule that could cause an uninformed client to improperly contribute to a Roth.
Also, contributions are always limited to $5,500 ($6,500 for clients age 50 or older) per year in 2015. Any contributions in excess of this amount will be improper even if the client otherwise falls below the income thresholds discussed above.
Correcting an Excess Roth Contribution
Regardless of the reason for the excess Roth contribution, the client will likely need to remove the excess Roth contribution amount from the account. There are a few options that can be used, depending on the date that the excess contribution is discovered.