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George Saenz, the Bankrate.com Tax Talk columnist Excess IRA contribution

Dear Tax Talk,
So I made a mistake. As a 20-year-old college student, my summer job income has been rather low. In fact, last summer I only made around $1,100. However, I had some extra money in savings that I invested into a Roth IRA, around $2,000. I found out my mistake when I filed my taxes (only allowed to invest what you earn) and that I was going to be fined for the excess contribution. I did some rough calculations and realized it would be smarter for me to pay the small fine now and leave the full amount in the IRA so that in the long run I have a larger amount of money compounding. I did this with the expectation that this fine was a one-time fine, and that next year the IRS would not come back and fine me. Was this a correct assumption?
-- Brian

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Dear Brian,
The original excess contribution was a mistake and your assumption is incorrect. Excess contributions to an IRA are subject to an annual excise (nicer way of saying penalty) tax of 6 percent of the over-contribution. Your excess contribution was $900 so your penalty is $54. The excise tax continues to apply until the year you withdraw the excess. Form 5329 is used to report the excise tax.

Now that you have caught your mistake, you have to withdraw the $900 or apply it to a subsequent year's contribution provided you expect to have wages in excess of the $900. A proportionate share of the income earned by the IRA has to be withdrawn as well and included in your income. If you had caught your mistake before the due date for filing your return (including extensions), you could have withdrawn the excess and proportionate income and you would not have to pay the 6 percent penalty.

To ask a question on Tax Talk, go to the "Ask the Experts" page, and select "taxes" as the topic.

Bankrate.com's corrections policy-- Posted: May 4, 2007
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