Can I Cancel an IRA Contribution?

Uncertain economic times often lead to unpredictable income and a host of related budgeting issues. For those who save for retirement in an IRA throughout the year, annual accounting may uncover excess contributions. Year end cash needs might also generate regret -- that first-quarter IRA contribution may be more than you can afford. Fortunately, there is a simple, penalty-free method for correcting either type of unwanted contribution, provided you complete the correction prior to the tax filing deadline.

There are a number of reasons you may choose to withdraw an annual IRA contribution. Some people may have contributed more to their IRA than intended. Others may find that a year-end accounting reveals an excess contribution, a deposit over and above the IRA limits for the year ($5,000 in 2010). Excess contributions can result from simple accounting errors, or they may be the result of the modified adjusted gross income rising higher than the Roth IRA phaseout limits ($105,000 for single filers in 2010).

You may withdraw an excess contribution at any time during the year and up to your tax filing deadline without penalty (April 15 for standard filers, October 15 for those with extensions). Excess contributions that remain in an IRA account after the tax filing deadline are subject to a penalty for the time they remain in the account.

If you make a correction, you must also remove any earnings from the contribution. Calculate earnings by determining the difference in the Fair Market Value of the account directly before the contribution and at the time of correction. This number is the growth of the account (it may be negative if you took a loss). Calculate the growth percentage by dividing the difference by the FMV of the account at the time of correction. Multiply this percentage by the total correction, and add that amount to your withdrawal (see IRS Publication 590 for a step-by-step chart). If you took a loss, your withdrawal will be less than the amount of your contribution.

Your IRA custodian reports the withdrawal on IRS Form 1099-R. Make sure to inform the custodian that this is a corrective withdrawal to ensure it is reported correctly. You do not need to report the amount of your contribution as income on your 1040 form if you do not take a deduction for that amount. You do need to report any earnings as income.

All excess contributions not corrected by the tax filing deadline are subject to a 6-percent tax penalty for every year that they remain in the account.