Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: I believe that my client contributed too much to her IRA in 2010.  What are the penalties associated with the excess contribution?

Answer: For 2010, the maximum contribution an individual can make to a traditional and/or Roth IRA(s), if under age 50, is the lesser of $5,000 or earned income.  An individual age 50 or older may contribute the lesser of $6,000 or earned income.  A contribution greater than these maximums is excessive.

An excessive contribution will also result if an attempted rollover from another IRA or qualified plan proves invalid. A defective rollover could occur, for example, because the 60-day limit for rollovers was exceeded, a portion of the rolled amount was subject to minimum distribution requirements and thus not eligible for rollover, or for numerous other reasons. Of course, a properly executed rollover will not be considered an excessive contribution no matter how large in amount.

If a taxpayer does not make a corrective distribution, a 6% penalty tax will be imposed on the excessive amount, for the current year and for every subsequent year, until the excess contribution is eliminated.

A taxpayer can correct an excessive contribution, and thus avoid a 6% penalty tax, by taking a corrective distribution on or before the due date of his tax return, including extensions, for the tax year during which the excessive contribution was made.  To make a corrective distribution, the individual must withdraw the excess contribution plus any income attributable to the excess amount (or minus any loss so attributable).

The portion of the corrective distribution representing the return of the excess contribution itself is not included in taxpayer’s taxable income.  However, that part of the distribution which constitutes earnings, if any, on the excess contribution, will be taxed.  If taxpayer is under age 59 1/2, this taxable portion of the distribution will also be subject to the 10% early withdrawal penalty, unless an exception applies.

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