Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What happens to excess contributions made to an IRA?

1. They can be rolled over to the next year

2. They are treated as taxable income

3. They can be withdrawn without penalty

4. They are non-deductible and do not grow tax-deferred

The correct answer is: They are non-deductible and do not grow tax-deferred

When excess contributions are made to an Individual Retirement Account (IRA), they are classified as non-deductible contributions, meaning they do not provide a tax deduction for the contributor. Additionally, because they exceed the annual contribution limits set by the IRS, these contributions do not grow tax-deferred like regular contributions. This aspect is critical as one of the main benefits of an IRA is the tax-deferral feature on the earnings within the account, which is negated for excess contributions. The treatment of excess contributions requires the account holder to take corrective action to avoid penalties, demonstrating the importance of adhering to the contribution limits imposed by the IRS. While there are options to rectify excess contributions, such as withdrawing them, those withdrawals don’t entitle the account holder to the same tax benefits as the properly made contributions. Understanding the specific tax implications of excess contributions ensures individuals can better manage their retirement accounts effectively and avoid unnecessary penalties.