What To Do If You Contribute Too Much to an HSA, IRA or 401k

Amanda M. says:

I contributed to my Roth IRA for 2020, but now I realize that my income will exceed the allowable annual limit. Can I fix this error and use the money to contribute to a traditional IRA instead, or do I have to pay a penalty?

Thanks for your question, Amanda. And congrats on earning too much to qualify for a Roth IRA! That’s a significant milestone that I’ll explain here.

While overcontributing to various tax-advantaged accounts—such as a retirement account, health savings account (HSA), and 529 college savings account—isn’t allowed, it can be easy to do by mistake.

I'll answer Amanda’s question and explain the contribution limits for various accounts and what happens when you over-contribute to them. You’ll learn how to easily correct an excess and avoid costly penalties.

What is an IRA?

IRA is short for Individual Retirement Account or Individual Retirement Arrangement, a tax-advantaged savings vehicle designed for individuals. It’s one of my favorite retirement accounts because anyone with earned income qualifies to contribute, even minors. It also offers more flexibility for taking withdrawals compared to other retirement accounts.

No matter how much you earn, you can max out a traditional IRA. However, as Amanda mentioned, there are annual income limits to qualify for a Roth IRA.

Note that the Roth IRA is the only type of retirement account that comes with an income threshold. Other types of Roth accounts, such as a Roth 401(k) or a Roth 403(b), don’t have an annual income limit.

You can only contribute to a Roth IRA when your modified adjusted gross income (MAGI) is below the following annual limits for 2020:

• Single tax filers can’t make contributions when you earn $139,000 or more and increases to $140,000 for 2021. 
• Married couples filing taxes jointly can’t make contributions when your household income is $206,000 or more and increases to $208,000 for 2021. 
• Married couples filing separate taxes can only make reduced contributions with MAGI less than $10,000 and are ineligible when you earn more.

What happens if you over-contribute to an IRA?

Now that you know who qualifies for a traditional and a Roth IRA let's discuss how much you can contribute and ways to correct an excess. 

For 2020 and 2021, you can contribute up to $6,000 to a traditional IRA, a Roth IRA, or a combination of both. If you're age 50 or older, you can contribute an additional $1,000, for a...

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