I may have made an ineligible contribution to a Roth IRA. What should I do?

Early this year (before mid-April) I received in excess of $11,000 in taxable inheritance income. The income was distributed from several annuities. I deposited$5,500 into a Roth IRA for the 2016 tax year and then another $5,500 for the 2017 tax year. I made less than$5,500 both this year and last year excluding the inheritance.

Am I correct that I have made ineligible contributions? If so, what are my options going forward along with their pros and cons?

• Why do you think they are ineligible? If you mean that you didn't pay tax - that's completely separate from making contributions to the Roth IRA. You will likely be required to declare this income and pay tax on it in your 2017 tax form. You can also remove the money from Roth IRA and use that to pay tax, with the note that if the money already grew in 2017, you will be required to pay tax on the gains of the portion you remove. – alexandroid Dec 15 '17 at 7:03
• @alexandroid Tax was withheld from the annuity distributions so that's not an issue. The issue is--and I just heard about this today and don't fully understand it yet--that I believe you are not supposed to deposit more in an IRA than your receive as "earned income". I worried that my 2017 contribution may be ineligible if inheritance doesn't count as earned income because my other income sources were less than $5,500 this year. And I'm worried that my 2016 income is ineligible because I made less than$5,500 in total income in 2016. – partyphysics Dec 15 '17 at 7:30
• From a quick skim, it looks like you may have exceeded the limits: this IRS page confirms the limit is "the maximum of $5,500 or your taxable compensation for the year" and this page lists in Table 1.1 what qualifies and then lists (some?) things that don't. Neither explicitly mentions inheritance, but the common factor seems to be things you have earned from your personal services (except alimony) so I would guess inheritance doesn't count. – TripeHound Dec 15 '17 at 8:15 • See the answer at money.stackexchange.com/questions/66595/… – user662852 Dec 15 '17 at 14:48 • Are you married and filing jointly? and if so, does your spouse have earned income? – user102008 Dec 15 '17 at 15:55 1 Answer You are quite correct that you have made ineligible contributions to your IRAs for 2016 as well as 2017. The 2017 contribution is easy to fix: just withdraw the contribution (and all earnings from it) by Tax Day in mid-April 2018. If you like, you can withdraw only what you need to:$5500 minus your taxable compensation for 2017 where compensation means things like wages or salary, self-employment income, commissions on sales, etc -- any payment for work of some kind -- but not inheritances, even if being a loving grandchild to a crotchety grandpa was hard work. This withdrawal can be done by writing to the IRA custodian and simply saying that you have changed your mind and have decided that you want to contribute only $X to your IRA for 2017, and would they please return the$5500 minus $X and all the earnings on the amount being returned. If you do this in timely fashion (don't send the request on April 15, 2018! postmarks count with the IRS, not with IRA custodians), there is no harm and no foul. Note that the earnings part of the withdrawal is taxable income to you. The 2016 contribution requires more work and payment of fines and excise taxes. Once again, you need to write to the IRA custodian explaining that you have over-contributed to your IRA for 2016 and wish to withdraw the excess and all earnings thereon so as to regularize your situation. Do this as soon as possible. There may be mandatory withholding of tax from the money distributed to you. • I know you can amend your previous year tax returns. Is there no way I can do something like that to avoid the penalty on my 2016 contribution? – partyphysics Dec 15 '17 at 18:10 • It is not an amendation of your 2016 tax return that is the issue. You have declared on your 2016 tax return that you earned less than$5500 and this number is presumably correct and not subject to change. So, what you_could_ have contributed to a Roth IRA for 2016 is fixed, and the fact that you_over-contributed to an IRA for 2016 cannot be changed. You could falsely amend your 2016 return to say that you had more earned income for 2016, but then you would owe income tax as well as Social Security and Medicare tax on the excess, not to mention penalties and interest for late payment... – Dilip Sarwate Dec 15 '17 at 18:27
• This is a most unfortunate error on my part – partyphysics Dec 15 '17 at 18:29
• (Continued) but I strongly advise you against doing so. Fix the problem by removing the excess contribution ASAP and pay the penalty and excise tax. Since this was a Roth IRA, there was no deduction, and the return of the excess contribution is not taxable income to you; the earnings on the contribution are taxable income to be declared on your 2017 return. – Dilip Sarwate Dec 15 '17 at 18:32
• Yeah, I wouldn't consider falsely amending my previous year's taxes a real option. I just brought it up to see if I could amend my previous year's IRA contribution without penalty, but I guess the answer is no. – partyphysics Dec 15 '17 at 18:46