No matter what the reason, contributing beyond the IRS limit could result in a tax penalty if you don't take steps to manage the franchise. You can eliminate excess IRA contributions or apply them to a future year, or consider investing in an IRA backed by Gold. You should also eliminate any interest or gain from excess money. And if you don't act quickly, you can pay a 6% special tax and early distribution taxes. Since the 6% excise tax only applies to the amount of the excess contribution of the Roth IRA and no penalty or income tax of 10% would apply to the amount of the excess contribution, in addition to the fact that the profits from the excess contribution remain in the Roth IRA and can grow tax-free, the idea is that the 6% special tax on the excess contribution to the Roth IRA ends up being considerably lower than if the investment were made with personal funds subject to the rates of individual income tax.
Let's say you don't do anything to fix it, you don't make additional contributions, and you haven't received any distribution from the IRA in the past three years. In the meantime, you won't have to pay an early withdrawal penalty to change the contribution year of your leftover funds, as you would if you had simply withdrawn the money. The IRS says it can apply the excess contribution from one year to a later year, as long as the total contributions for that last year are lower than the contribution limit for the year. An excessive contribution to an IRA usually occurs if you contribute more than the contribution limit, contribute more than your earned income, or make an undue cumulative contribution to an IRA (e.g., a strategy that has been gaining some popularity lately revolves around the concept of making excessive contributions to a Roth IRA to generate additional tax-free returns in the Roth IRA).
You can recharacterize IRA contributions up to the due date of your tax return, including extensions. This is between the starting point and the end point of the income range where Roth IRA contributions are phased out. However, you must pay the 6% special tax on the excess amount of your IRA each year until the franchise is withdrawn. According to the IRS, you can withdraw contributions on or before the deadline for filing your tax return.
It's surprisingly easy to contribute too much to your Roth Individual Retirement Account (IRA) if you don't pay attention or understand the rules. If you think you'll be close, make a quick requalification by transferring any Roth deposits from that calendar year to a traditional IRA. However, a person cannot reduce an excess contribution by applying it to a previous year in which an amount lower than the maximum allowable amount was provided. You can also apply the excess contribution and your earnings to a future year's Roth IRA, as long as you stay within that year's limits.
For either type of account, you must also report earnings from excess contributions as income for each year you earned income. Keep in mind that for the Back Door Roth method to work, you first need to start by putting the money into a traditional IRA and then convert it to a Roth.