What happens to excess contributions in an IRA if they are not withdrawn?

When excess contributions are made to an Individual Retirement Account (IRA) and are not withdrawn, they incur a 6% annual excise tax. This tax is applied to the amount of the excess contribution for each year that it remains in the account. The purpose of this tax is to discourage individuals from exceeding the contribution limits set by the IRS, which are intended to promote retirement savings while maintaining certain tax advantages.

It's essential for account holders to monitor their contributions carefully to avoid this penalty. If they discover they have made excess contributions, they have the option to remove those excess amounts before the tax filing deadline for that tax year, allowing them to avoid the excise tax. However, if they do not take action to withdraw the excess contributions, the 6% tax will be assessed annually until the excess amount is removed or the individual reaches retirement age.

Understanding this penalty emphasizes the importance of adhering to contribution limits for IRAs and serves as a reminder for savers to keep track of their contributions throughout the year.