Contributing regularly to an Individual Retirement Account (IRA) is one of the pillars of a good retirement planning strategy. But exceeding IRS limits can turn this good habit into a source of tax penalties.
Whether you have a Traditional IRA or a Roth IRA, it’s essential to understand the rules, the risks and the solutions to prevent your retirement savings from being amputated by unnecessary taxes.
IRA contribution limits
For the 2025 tax year, the annual contribution limit for an IRA is set at $7,000 for those under 50, and $8,000 for those benefiting from the catch-up contribution.
These limits are cumulative for all your IRAs, so you can’t put $7,000 into a Traditional IRA and another $7,000 into a Roth IRA in the same year.
When it comes to Roth IRAs, you also need to keep an eye on your income. Your eligibility depends on your Modified Adjusted Gross Income (MAGI). If your income exceeds the thresholds set by the IRS, your allowable contributions will be reduced… or even prohibited.
Why overfunding an IRA can happen
The causes of overcontributing to an IRA are varied:
- Forget that the limit is global and not per account.
- Automating payments without recalculating after an increase in salary or a change in family situation.
- Underestimating annual income, making a Roth IRA partially or totally ineligible.
- Contribute more than your annual taxable income (especially for the self-employed).
Tax consequences when overcontributing to an IRA
If you exceed the limits and don’t correct the excess before the deadline, the IRS applies a 6% tax on the excess amount every year, for as long as the money remains in the account.
Worse still, if the excess has generated gains, these will have to be declared as taxable income. This can impact your current and future tax bill, including your Social Security benefits if your taxable income increases.
Three ways to correct the situation
The good news is that there are several ways to correct an excess contribution, provided you act quickly.
Return of excess contribution and earnings
Before the tax return deadline (generally April 15, or October 15 with extension), you can ask your financial institution to make a “return of excess contribution”.
You’ll avoid the 6% penalty, but you’ll have to pay tax on the earnings generated.
Recharacterize your contribution
If you contributed to a Roth IRA when your income made you ineligible, you can transfer the excess to a Traditional IRA.
The IRS will then consider that the contribution was made directly to this account, which may erase the penalty.
Apply the excess to the following year
You can choose to keep the excess and deduct it from your contributions for the following year. But in this case, the 6% tax will be due for the current year.
After the deadline: Still time to limit the damage
If you discover the error after filing your tax return, you have until October 15 (in the case of an extension) to withdraw the excess and file an amended return (Form 1040-X and Form 5329). After this deadline, the penalty will be due for at least one year.
Prevention rather than cure
The best strategy to avoid IRA overfunding is vigilance:
- Monitor your contributions throughout the year, especially if you have several accounts.
- Check your eligibility for the Roth IRA if your income rises.
- Adjust your automatic payments after a professional or personal change.
- Keep accurate statements to avoid confusion when planning your retirement.
Overfunding an IRA is not an irreversible disaster, but it can be costly if you delay taking action.
Knowing the IRS rules and quickly correcting any mistakes will protect your capital and optimize your retirement planning.
After all, every dollar lost in penalties is a dollar that won’t be working for your retirement or supplementing your Social Security income.
IRAs FAQs
An IRA (Individual Retirement Account) allows you to make tax-deferred investments to save money and provide financial security when you retire. There are different types of IRAs, the most common being a traditional one – in which contributions may be tax-deductible – and a Roth IRA, a personal savings plan where contributions are not tax deductible but earnings and withdrawals may be tax-free. When you add money to your IRA, this can be invested in a wide range of financial products, usually a portfolio based on bonds, stocks and mutual funds.
Yes. For conventional IRAs, one can get exposure to Gold by investing in Gold-focused securities, such as ETFs. In the case of a self-directed IRA (SDIRA), which offers the possibility of investing in alternative assets, Gold and precious metals are available. In such cases, the investment is based on holding physical Gold (or any other precious metals like Silver, Platinum or Palladium). When investing in a Gold IRA, you don’t keep the physical metal, but a custodian entity does.
They are different products, both designed to help individuals save for retirement. The 401(k) is sponsored by employers and is built by deducting contributions directly from the paycheck, which are usually matched by the employer. Decisions on investment are very limited. An IRA, meanwhile, is a plan that an individual opens with a financial institution and offers more investment options. Both systems are quite similar in terms of taxation as contributions are either made pre-tax or are tax-deductible. You don’t have to choose one or the other: even if you have a 401(k) plan, you may be able to put extra money aside in an IRA
The US Internal Revenue Service (IRS) doesn’t specifically give any requirements regarding minimum contributions to start and deposit in an IRA (it does, however, for conversions and withdrawals). Still, some brokers may require a minimum amount depending on the funds you would like to invest in. On the other hand, the IRS establishes a maximum amount that an individual can contribute to their IRA each year.
Investment volatility is an inherent risk to any portfolio, including an IRA. The more traditional IRAs – based on a portfolio made of stocks, bonds, or mutual funds – is subject to market fluctuations and can lead to potential losses over time. Having said that, IRAs are long-term investments (even over decades), and markets tend to rise beyond short-term corrections. Still, every investor should consider their risk tolerance and choose a portfolio that suits it. Stocks tend to be more volatile than bonds, and assets available in certain self-directed IRAs, such as precious metals or cryptocurrencies, can face extremely high volatility. Diversifying your IRA investments across asset classes, sectors and geographic regions is one way to protect it against market fluctuations that could threaten its health.