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Excess IRA Contribution Penalty

Last Updated February 25, 2011

Question: 

I am 64 years old and I am on social security. In January 2011, I made a 2010 contribution to my IRA. In doing my 2010 taxes I was penalized 6% on the contribution. Why?

Answer provided by Appleby Retirement Consulting Inc. Appleby Retirement Consulting Inc provides Consulting, Coaching and Content on IRAs and other retirement plans to Financial, Tax and Legal professionals. 

Answer: 

You should not have been penalized on the contribution. The 6% penalty ( excise tax)  applies to an excess contribution only if it is not removed by your tax filing deadline, including extensions.

Some background

Your IRA   contribution was deemed an excess contribution, because you did not have eligible compensation for 2010. One of the eligibility requirements that you must meet in order to make a contribution to an IRA is having eligible compensation for the year. Eligible compensation includes salary, wages and tips. For purposes of making a contribution to an IRA, social security income is not considered eligible compensation.

As such if your social security is the only income you received during 2010, you are not eligible to make an IRA contribution for 2010.

The question now becomes, “since you did in fact make the contribution, what should be done?”

You should remove the amount from your IRA as a 'return of excess contribution’ .  You have until your tax filing deadline, including extensions, to remove the amount as a return of excess contribution. Since you already filed your tax return (which means you filed it by the deadline) you receive an automatic 6-month extension to correct the error (under the return of excess method). This automatic 6-months extension means that you have until October 15, 2011 [1] to correct the error.

The 6% excise tax applies only if you fail to remove the excess amount by the deadline.

Our suggestions (assuming that you did not receive any eligible compensation during 2010):

·         Contact your IRA custodian and instruct them to remove the IRA contribution as a return-of-excess contribution. They may have a special form for this purpose.

·         Ensure that net income attributable (NIA) to the excess is removed along with the contribution. NIA can be earnings or losses.

·         Amend your tax return to remove the 6% penalty

Your IRA custodian will send you a Form 1099-R for the correction by January, 31 of next year. If there are any earnings removed with the excess, you will need to include on your tax return for 2011.



[1] If October 15 falls on a weekend or public holiday, the deadline is extended until the next business day