Course: Retirement Planning
Lesson 1: Using IRAs to Build and Distribute More Retirement Income
If an IRA owner over-contributes to his IRA, the owner must remove the excess contribution AND the earning on those contributions by the tax filing date to avoid a 6% tax penalty. However, the 6% penalty tax is only on the excess contribution and not the earnings. Is this correct? What happens if a person removes only the excess contribution (since there isn’t a penalty tax on the earnings)? In effect, could he defer taxes on the earnings of the excess contributions without recourse from the IRS?
If only that were true! Here are the dynamics.
- The taxpayer can avoid the 6% excess penalty if both excess contribution and excess earnings (on excess contribution) are removed by the due date.
- If the earnings are not withdrawn by the due date, the 6% excess penalty will apply.
- The earnings on the excess contribution are subject to the 10% premature distribution penalty however, unless the withdrawal qualified for one of the exceptions (see Withdrawals from Traditional IRAs before Age 59½