How do contributions interact with each other?

Financial Planning Tax Strategies
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Say a couple who is married filing jointly has one wage earner that earns $120,000 per year in salary, paid monthly. ($10,000 per month). Both spouses will be in their 40s in 2025, so not yet eligible for catch up contributions. Outside of working, the couple’s investments in taxable accounts generate roughly $10,000 of gross income per year between dividends, interest, and capital gains. So it’s enough to have a buffer, but not enough to throw them past the earnings level where they can no longer contribute to Roth IRAs.

That couple’s strategy when it comes to retirement savings is to “front-load” contributions to Roth style accounts, getting as much as possible into the working spouse’s Roth 401(k) and each spouse’s Roth IRA early in the year. They use those existing after-tax savings to make the Roth IRA contributions and cover their costs during the “lean months” while the Roth 401(k) contributions are being made.

The company that employs the working spouse allows employees to contribute up to 50% of gross salary into the company’s 401(k) plan. As a result, at the end of January, 2025, the couple would have contributed a total of $19,000 to Roth-style retirement accounts for the year 2025. ($5,000 to the Roth 401(k), and $7,000 to each of two Roth IRAs).

But here’s the twist: say that on January 31, 2025, that working spouse gets unexpectedly laid off, with no severance. For the sake of making the story work, let’s say that neither spouse finds a job or earns contractor style income for the remainder of 2025.

Taken individually and assuming none of the other retirement contributions existed, it would seem to me that any one of the Roth 401(k) and Roth IRA contributions would have been ok. Put any two or all three together, however, and the couple’s total contribution to their retirement plans would exceed their total gross compensation from work for the year.

So here are the questions: in addition to being out of work, is the couple now in trouble with the IRS for over-contributing to their retirement plans? And if they are in trouble with the IRS, is there anything they can do about it, aside from “find a job to cover the gap before the end of 2025”?

Thanks in advance.

Regards,
-Chuck

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No expert here, but couldn’t you just withdraw some of the $ you put into the Roth IRA before the end of the year? May need to take out any profits also.

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With only $10k in earned income for 2025, and having contributed $14k to their Roth IRAs, yes, they have overcontributed to their Roth IRAs by $4k. The easiest fix would be to find any kind of job that will pay at least $4k during Feb - Dec - barista, temp jobs, etc.

If they don’t manage to earn at least $4k during the rest of the year, they can withdraw the extra $4k, plus any earnings on that $4k, before the due date of their return. They will owe taxes and an early withdrawal penalty on the earnings. To minimize the earnings, withdrawing shortly after the contribution, rather than waiting until shortly before the tax return is due is likely to be better in 2 out of 3 years.

Or, if they think they will have at least $4k in earned income in 2026 they could elect to pay an excise tax of 6% ($240) on the excess contribution and use that $4k as part of their 2026 contribution.

There is no problem with the $5k contribution to their workplace plan.

Edite to add:
I would point out that even when front-loading, if they had just contributed the amount of each paycheck as they received it, they would have avoided any issues. It would have delayed getting the total contribution in by a few weeks, but would still have been pretty front-loaded.

AJ

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As usual, thanks so much, AJ!

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