How to Fix a Mistaken Roth IRA Contribution and Avoid IRS Penalties

How to Fix a Mistaken Roth IRA Contribution and Avoid IRS Penalties

Introduction

Mistakenly contributing to a Roth IRA when you meant to contribute to a Traditional IRA can lead to tax consequences if not corrected properly. Whether the amount is large or small, here's what you need to know to fix the error and avoid IRS penalties.

Step 1: Understand the Excess and Deadlines

• IRA Contribution Limits: For 2025, the contribution limit is $7,000 (or $8,000 if you're age 50+). Any amount above these limits is considered an excess contribution.

• IRS Correction Deadline: You have until April 15, 2026, or October 15, 2026 (with a tax extension), to correct the mistake and avoid the 6% annual excise tax on the excess.

Step 2: Remove the Excess Contribution

• Contact Your IRA Custodian: Request a "return of excess contribution," including all earnings (or losses) generated by the excess.

• Withdraw Both Principal and Earnings: Failure to remove the earnings, as well as the excess contribution, will result in penalties. The custodian will calculate this for you.

• Tax Implications:

  • The excess contribution is not taxed (Roth contributions are after-tax).

  • Any earnings must be reported as taxable income for 2025.

  • No 10% penalty applies to the earnings if the removal is done by the IRS deadline.

  • Documentation: Your IRA custodian will issue Form 1099-R in early 2026 to document the withdrawal.

Step 3: Recharacterize to a Traditional IRA (Optional)

• If your intention was to contribute to a Traditional IRA, you can recharacterize up to the allowable contribution limit.

• How to Recharacterize:

  • Contact your custodian and request a transfer of the allowed amount (e.g., $7,000) from Roth to Traditional IRA.

  • The custodian must include associated earnings in the transfer.

  • Deadline: This must be done by October 15, 2026, if you file an extension.

  • Note: You can only recharacterize up to the legal limit. Any amount over the limit must be removed.

Step 4: Report Properly to the IRS

• Report Earnings: Declare earnings from the withdrawn excess as income on your 2025 return.

• Avoid the 10% Penalty: Use Form 5329 and exception code "21" if you're under age 59½ to avoid early withdrawal penalties on the earnings.

• Report Recharacterization: Attach a short statement with your return and ensure the IRS receives Forms 1099-R and 5498 from your custodians.

• File Form 5329: If any excess remains uncorrected after the deadline, report it on this form and pay the 6% penalty.

Summary

• Fix it fast: Withdraw excess contributions and earnings before April 15, 2026.

• Recharacterize: Move allowable contributions to a Traditional IRA if that was your intent.

• Report earnings: Include on your tax return and use IRS Form 5329 as needed.

• Avoid penalties: Act within the IRS timeline to sidestep a 6% excise tax that recurs annually.

• Making an IRA contribution error is fixable. Acting promptly and following IRS guidelines ensures your retirement savings stay intact and penalty-free.