Using IRAs to save for retirement is one of the smartest moves you can make. What's not smart, however, is breaking the IRS rules governing IRAs.
Fortunately, if you accidentally break the rules, you can go back and fix things -- as long as you don't wait too long.
How Much Is Too Much
One key rule you have to follow with retirement accounts is not to contribute too much in any given year. Typically, the limit on contributions is $5,000. It's $6,000 if you're age 50 or older.
But a special rule applies to Roth IRAs. If your income is above a certain limit -- $110,000 for single taxpayers, or $173,000 for joint filers -- then the amount you can contribute to a Roth is reduced. And if you earn an income more than $125,000 for singles and $183,000 for joint filers, you can't contribute to a Roth at all.
What often happens is that people contribute to a Roth early in the year before it's clear what their income is going to be. Only later in the year does it become obvious that they'll go over the income limit and therefore no longer be eligible to contribute.
How to Fix a Contribution Boo-Boo
The IRS realizes that this isn't the fairest of situations, so the tax law allows a couple of ways for you to fix things.
One solution is simply to take out the excess contribution from the Roth, as well as any earnings the money generated while it was inside the account. As long as you do that before the final due date for your return including extensions -- typically October 15 of the following year -- you can avoid a 6% penalty for excess IRA contributions.
The second solution is to do what's called a recharacterization. By arranging for a direct transfer from your Roth to a traditional IRA, you'll be treated as if you'd never contributed to the Roth in the first place, but you'll still have your money inside a tax-favored retirement account. Moreover, you're always allowed to contribute to a traditional IRA, although you may not be able to deduct those contributions on your tax returns if your income is above certain limits and you or your spouse have access to a retirement plan at work.
Before you try to do this on your own, talk to the financial institution that has your IRA. The institution should be able to orchestrate things so that the IRS never knows there was anything wrong. Don't you wish you could solve all your tax problems that easily?
Motley Fool contributor Dan Caplinger has never made a mistake he didn't learn from. You can follow him on Twitter @DanCaplinger.