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How to Deal with Improper Roth Contributions

There are three courses you can take if you've contributed to a Roth IRA when you shouldn't have.

Question: My customer "Katy" contributed $5,500 to a Roth IRA in 2017, but now that her income tax return is completed (it's on extension), we've figured out that she was not eligible to contribute to a Roth IRA--her income was too high. What penalties does Katy face for this improper Roth contribution, and what are her options for correcting the mistake, if any? She is younger than 59 1/2; her other options for 2017 were to make a nondeductible contribution to her traditional IRA or make no IRA contribution.

Answer: The first step is always to figure out exactly what "crime" has been committed. In Katy's case, the problem is an excess IRA contribution--she made a contribution to her Roth IRA that she was not eligible to make. This is an excess contribution because her legal maximum 2017 Roth IRA contribution was zero and she actually contributed $5,500. The penalty for an excess contribution is 6% of the excess contribution ($330), reapplied annually until the excess contribution is removed from the account (or treated as part of a legal contribution in a later year--see Option 3).