Calculating earnings on multiple excess contributions
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A friend has a SEP-IRA to which he automatically made monthly contributions of $1,000. During the course of the year his business dropped off, reducing his allowable SEP contribution limit, yet he forgot to adjust his automatic contributions. So at the end of 2011, he had contributed almost $8,000 more to his SEP than he should have.
I know that in removing the excess contributions, earnings on the excess contributions have to be calculated and removed as well. In order to calculate those excess earnings, does one have to calculate earnings on each monthly contribution separately? Or can one simply treat all the excess monthly contributions as, in effect, a single excess contribution? If so, would that require a much more complex formula?
Thanks in advance for your help,
Permalink Submitted by Alan Spross on Fri, 2012-03-30 23:45
The excess contributions are deemed to be the last contributions made, in this case approximately the last 8 contributions made. Each of these 8 were in the SEP from different contribution dates and therefore there should be 8 calculations made. Most IRA custodians have software that does all these calculations and produces a consolidated amount of earnings or loss. Of course, the custodian can also refuse to do the calculation, dumping that responsibility back to the SEP owner.
I expect that if the SEP owner wants to abbreviate the process and come up with the figure himself using some consolidated contribution date, the IRS will not second guess the calculation unless it is widely out of line.
Permalink Submitted by Geoffrey Foisie on Sat, 2012-03-31 00:51
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Alan
Since I’m helping my friend, the thought of separate calculations put me in a cold sweat but I think I have worked it out on the spreadsheet. If I did it right, the separate monthly calculations worked out to a higher total “excess earnings” by 24% than a single calculation of “excess earnings” combining all the monthly contributions.
Thanks very much for your informative answer.
Permalink Submitted by Alan Spross on Sat, 2012-03-31 01:17
Well, higher earnings means a larger distribution and more tax and penalty. The 24% difference is substantial and is possibly attributed to the single “opening balance” you chose. This would occur if the single opening balance was at a relative market high during the 8 month period vrs the average market level at the time of the 8 contributions. I assume you were using the total SEP IRA value changes, not just what each contribution was invested in……………
Permalink Submitted by Geoffrey Foisie on Sat, 2012-03-31 01:29
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“I assume you were using the total SEP IRA value changes, not just what each contribution was invested in……………”
Yes, I was.
Would the penalty be due to an “early distribution” since he is under the required age?
Permalink Submitted by Alan Spross on Sat, 2012-03-31 02:22
Yes, the 10% penalty is only on the amount of earnings distributed. Of course, the actual excess contributions cannot be deducted in the first place.
There is also an option to carry over the excess amount to the following year, but this is usually not a good idea because the excise tax for the excess amount carried over is 10% instead of the usual TIRA rate of 6%.
Permalink Submitted by Geoffrey Foisie on Sat, 2012-03-31 11:28
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Thanks again.