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

What is the consequence of making an excess contribution to an IRA?

1. It will be considered a gift

2. It will increase the fund's growth potential

3. It is subject to a penalty

4. There is no monetary consequence

The correct answer is: It is subject to a penalty

When an individual makes an excess contribution to an IRA, meaning they exceed the allowable limit set for contributions, the Internal Revenue Service (IRS) imposes a penalty on that excess amount. Specifically, the penalty is typically 6% of the excess contribution for each year it remains in the account. This consequence serves as a deterrent against over-contributing and ensures the integrity of retirement contribution limits. The IRS has specific thresholds regarding how much can be contributed to IRAs, which can vary based on factors such as the type of IRA (traditional or Roth), the age of the contributor, and other considerations. If funds are mistakenly over-contributed, individuals are advised to withdraw the excess contribution and any earnings on it before the tax filing deadline to avoid the penalty. This understanding highlights the importance of adhering to contribution limits to not only secure tax advantages but also to avoid unnecessary financial penalties that can complicate one’s investment strategy and tax situation.