In June, I resigned from my job to join a new company. My former employer mistakenly sent my final pay to my IRA rather than to my checking account. I need access to this money to pay for my COBRA. My former employer basically told me to ask for a refund, which is not possible from my IRA account. I was advised, however, that I could request an excess contribution removal (ECR) to have the mistakenly deposited money transferred to my checking account. My question is, if I request the ECR, will I owe taxes on this money? The amount to be transferred is fairly low, around $2,000.
If I am reading this correctly, you had a certain amount of your regular net pay voluntarily contributed to a personal IRA account on your behalf and the balance deposited to your checking account. 100 percent of the final net check was contributed to their IRA account (in error), rather than the normal split.
The information does not indicate whether you are a participant in an employer sponsored plan (either at the prior or the new employer) and whether you have income greater than the limits ($73,000 for a single taxpayer or $121,000 for a married taxpayer) to allow an IRA deduction on your income tax return. The question appears to indicate the IRA is your personal IRA rather than an employer-sponsored SEP-IRA or SIMPLE-IRA. If employer-sponsored, the former employer might be required to request the correction. However, the comments in this response are limited to responding to the circumstances where this is a traditional IRA established by you, outside of any work-sponsored situation.
If the amount is not an excess contribution because the total contributions for the year are less than $5,500, (the annual contribution limit), I don’t see a basis for an excess contribution removal. If the amount is in excess of $5,500, the excess can be withdrawn from the IRA any time up through April 15 of the year following, to the extent of the excess only, without any tax consequence (the reported year’s contribution would be reduced and no income would be reported on distribution of the excess). This only provides the ability to withdraw an excess over $5,500, though.
All is not lost if the withdrawal is not an excess. You should be able to withdraw enough money needed for the COBRA payment without any additional tax. There will be no additional income tax to you because the distribution will be income but will be offset by the greater deductible contribution made through the error. The amount remitted to the IRA in error will produce an IRA contribution deduction on your federal tax return for the total contributed, and the amount contributed in error will offset the income reported as a distribution. You should include a Form 5329, Additional Tax on Early Distributions, when filing your return and should indicate no (an exception to the) penalty on the distribution taken to make your COBRA payments. (There is an exception to penalty in the law that allows IRA distributions for payment of health insurance premiums while unemployed or because of a job change where COBRA may be required for a period of time).
Unfortunately, any amount withdrawn in excess of COBRA insurance payments will not escape the 10 percent penalty. And so, if you are trying to withdraw any amount over COBRA, there is a 10 percent tax consequence on the excess withdrawn over the amount needed for COBRA.
The answer for a correction, under a “regular” IRA scenario, is simply not as easy as requesting an ECR, which is a remedy only applicable to employer sponsored plans, such as 401(k) plans.
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Answered by: Timothy C. Hilbert, CPA, is a director of audit and accounting and professional services industry group leader with Kreischer Miller in Horsham, Pa.