Save Too Much? Fix Excess Retirement Contributions Penalty-Free

0:00Could you accidentally have saved too much in your retirement or health accounts? Saving too much might not seem like a problem to worry about, but there is a downside to exceeding annual contribution limits for tax-advanced accounts, like a workplace retirement plan, IRA or HSA, and that's paying penalties. For this podcast, we'll review how to fix common contribution errors, so you avoid penalties and pay as little tax as possible. Plus, I'll review why over-contributing can actually be easy to do and tips for avoiding it. Welcome back to episode 1,000-4 of Money Girl. I really appreciate you downloading the show and spending some time with me. I'm Laura Adams, an award-winning author, spokesperson, money-speaker, and I'm the founder of the Money Stack, that's my sub-stack newsletter.

1:00Free subscribers automatically receive my Money Success Toolkit, which includes the exact templates I use to manage my finances. So I hope you'll check that out. You can learn more, ask your money questions, and sign up for the Money Stack for free at LauraDatoms.com. You can also leave a voice message with your question or comment by calling 302-364-0308. I'd love to feature your question on Finance Friday. That's our weekly Q&A bonus edition of the show. All right, so let's talk about over-contribution penalties. Catching and correcting an over-contribution to any kind of tax-advanced account as quickly as possible is critical. That's because you're violating IRS rules and will have to pay expensive penalties. Unless you remove the excess funds by a deadline, we'll talk more about how to do that.

2:01For IRAs and HSAs, the IRS imposes a 6% penalty for every year that an excess remains in your account. For example, let's say you over-contribute $1,000 to an IRA this year and you don't correct it. In that case, you've got to pay $60. That's 6% of the $1,000 over-contribution. You've got to pay that this year, $60 next year, and then $60 next year, and so on until that $1,000 over-contribution is removed. With a workplace retirement plan like a 401k or a 403b, the rules are a little different and over-contribution penalty is actually double taxation. For example, if you don't remove an excess by April 15, you're going to pay taxes on that over-contribution in the year that you made the contribution and you're going to pay it again when you withdraw it in retirement.

3:02Note that you can't just withdraw and accounts excess contribution. You also must withdraw any earnings it generated like interest, dividends, or capital gains. Therefore, you typically need an account custodians' help in calculating this and correcting an account and filing the necessary tax paperwork. If you withdraw both your excess contributions and the earnings by the tax deadline that I'll review, you avoid penalties. However, taking excess earnings out of a retirement account requires you to pay income tax on them for the year the contribution was made. If your over-contribution resulted in any income and any earnings, you do have to pay tax on that. There's really no getting around that. In addition, taking funds from a tax advantage to account before a certain age, like $59.5 or a retirement account, typically means incurring a 10% early withdrawal penalty.

4:04But the good news in this podcast is that making a correction by your tax filing deadline allows you to skip that 10% penalty no matter your age. However, missing the correction deadline means you would be subject to a 10% penalty if you're younger than 59 and a half. Now I mentioned that the correction deadline is your tax filing date. And that's typically April 15, however, for IRAs and HSAs, if you file a tax extension, you actually have until October 15, so you get an extra six months to correct an over-contribution error. But that's not the case for workplace retirement plans, with those you do have to correct them by April 15. So let's talk about how to correct an over-contribution that you might make to a workplace retirement plan and why this might happen in the first place. If you're fortunate enough to have a retirement plan at work, it's an incredibly valuable

5:09benefit, especially if you receive employer matching. The annual contribution limits typically increase slightly each year, but I'll review them for 2026. So this year you can contribute up to 24,500 or up to 32,500 if you're over 50. However, there is a special new rule for employees aged 60, 61, 62 and 63. For those four years, the allowable limit is higher at $35,750. However, amounts contributed by your employer, maybe it's from matching contributions or even profit sharing. Those don't count toward those limits. So any excess can only come from the amounts that you contribute from your own paychecks. While workplace retirement plans always have custodians and they typically have software to flag your account and prevent you from exceeding the annual contribution limit for your age,

6:13there are still situations when an over-contribution can easily happen. For instance, let's say you have two jobs that each offer a retirement plan or maybe you switch jobs during the year, so you've got two different plans during the year. Your total contributions can't exceed the annual limit. So let's say you're under 50 and you contribute 15,000 to 401k A and 15,000 to 401k B in 2020. So in that case, you've contributed $30,000 to 401k A. That is over the annual limit. Remember I said it's $24,500. So you've actually exceeded the annual limit by $5,500, even though each of the individual accounts looks just fine. Remember that different payroll departments and retirement plans don't communicate with each other. They only track what you contribute to their respective plans.

7:13So in this example, they would have no way of knowing that you've contributed too much to a 401k for the year. Note that if you're over 50 and my example, you'd actually be under the limit, which is $32,500, due to allowable catch-up contributions. So be sure to check the limit based on your age and it's your age by December 31st of the year that there could be an over-contribution. Another situation when it's easy to over-contribute is when you get a year in bonus. So maybe your contributions are sent as a percentage of your wages. In that case, it could be an unexpectedly high contribution limit that throws you over the limit. Again, it's your responsibility as a retirement plan participant to ensure that you don't contribute too much for the year. If you discover an over-contribution to one or more workplace retirement plans, contact your plan administrators and custodians.

8:14They can help you determine the amount of excess contributions plus any earnings that must be withdrawn. You'll receive the excess cash plus earnings or less any losses that the contribution generated. If the contributions were traditional or pre-tax, you're typically going to need a corrected W2, showing the returned amount as higher taxable wages. However, that's not an issue for an excess after-tax Roth contribution. With either a traditional or Roth plan, you must claim any earnings on an excess contribution as investment income in the year it's distributed. But as I mentioned, you won't owe an early withdrawal penalty if you make a correction by April 15th of the following year. Otherwise, you could be subject to a 10% early withdrawal penalty on excess earnings if you're under 59.5. Be aware that there is a new retirement rule for high earners that starts in 2026.

9:17If you made more than $150,000 in 2025, the IRS now requires 401K catch-up contributions to be Roth made on an after-tax basis. So if you try to make them pre-tax, your plan, administrator, or custodian should automatically re-characterize them, but you want to keep an eye on your paystab to make sure there aren't any errors. OK, now let's talk about how to correct over-contributions to an IRA. An IRA, as you probably know, is a tax advantage savings vehicle for individuals with qualifying earned income. No matter how much you earn, you can max out a traditional IRA every year. However, a Roth IRA is the only type of retirement account that imposes an annual income limit to qualify. In other words, if you earn too much, you don't qualify. For 2026, you can contribute up to $7,500 or up to $8,600 if you're over 50 to an IRA.

10:24Now let's say you're under 50 and you maxed out a Roth IRA with a $7,500 contribution. But later in the year, you discover that you're going to receive a very nice bonus at work, which will make your income too high to qualify for a Roth IRA. That's a nice problem to have, but it does mean you're going to have to make a correction. As I mentioned, excess contributions in an IRA get penalized at 6% per year for each year they remain there. I recommend contacting your custodian to help you calculate the total of your excess contributions and any earnings, removing them before your tax filing due date, including an extension to October 15 will solve the problem. But still, timely corrections of an IRA mean you must pay income tax on any earnings that were generated by the excess. However, there is not a 10% early withdrawal penalty if you're under 59 and a half.

11:25Your IRA custodian will send you Form 1099R showing your taxable income to submit with your tax return. All right, now let's talk about an HSA. If you're covered by an HSA qualified health insurance plan, you qualify to open an HSA and to make tax deductible contributions up to an annual limit. You can use the contributions and any investment earnings to pay certain health care expenses tax-free. So these are great accounts. HSA contributions can come from you, somebody else like a family member or even an employer. For 2026, the HSA contribution limit if you have an individual health plan, so it's just you on the plan, is $4,400 or it's $8,750 if you've got a family plan with other people on the plan besides you. In addition, those over age 55 can contribute an additional $1,000.

12:25What's really tricky about HSA limits is that they include all contributions. So unlike employer matching on a workplace retirement account, employer contributions to your HSA are included in your annual limit. That can make it easy to lose track and over-contribute if your employer makes contributions that are not clearly defined or they're variable. The onus is on you, not your employer, to catch and correct excess contributions. Another situation when you could over-contribute is when you make a large contribution early in the year, but let's say you lose your HSA eligible health plan later on. For instance, if you leave your job, maybe you change to a non-HSA qualified health plan, in that case you're not allowed to make additional HSA contributions. So that means you've got to remove a proportional amount of excess if you lose HSA eligibility

13:29during the year. If you over-contribute to an HSA and don't correct it, you must pay a 6% penalty each year on the excess that remains in your account. But if you catch the mistake before you file taxes, including extensions, you can avoid the penalty by withdrawing the excess plus any earnings. And just like with the traditional IRA, excess HSA contributions returned to you become taxable income. So if an excess came from your employer, it must get added to your W2, showing higher taxable income. In addition, excess earnings are subject to income tax. I recommend contacting the administrator of your HSA to discuss correcting an annual overage. The custodian must file form 1099SA showing a distribution of excess contributions and correct your form 5498SA, which shows annual HSA contributions.

14:30As you can see, even making an honest mistake with a tax-advanced account can get tricky. So be sure to get custodial advice and correct it quickly. Put a note on your calendar to review your retirement accounts and your HSA at the beginning of December. So you still have enough time to make changes before the end of the year. If you find a problem that you can't correct before the new year, getting excess contributions corrected in the first quarter of the new year, you know, that's the next best option. You might have a little income tax to pay, but the faster your account gets cleared up, the less you'll have to pay. I hope this show has been helpful to remind you what the contribution limits for the special accounts are and what to do if you find yourself putting in too much for the year. That's all for now. I'll talk to you soon. Until then, here's to living a richer life. Money Girl is a quick and dirty tips podcast. We've got a great team. I want to thank Steve Rickeyberg for audio engineering the show.

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