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

What is the penalty for making excess contributions to an IRA?

1. They are fully deductible

2. They incur a 10% tax penalty

3. They are non-deductible and do not grow tax-deferred

4. There is no penalty

The correct answer is: They are non-deductible and do not grow tax-deferred

When considering the consequences of making excess contributions to an Individual Retirement Account (IRA), the correct understanding is that excess contributions are typically subject to specific penalties and tax implications. Excess contributions to an IRA indeed incur a 6% excise tax on the amount over the allowable limit for each year that the excess remains in the account. However, the other aspects of the correct option highlight that these excess contributions are non-deductible and do not grow tax-deferred. This means that not only will you face penalties, but you also miss out on the tax advantages that IRAs are designed to provide. In essence, if contributions exceed the limit, they become non-deductible, meaning they won't provide the tax deduction benefit typically associated with traditional IRAs. Consequently, the growth on these excess contributions does not enjoy the tax-deferred status that is a hallmark of IRA accounts. Understanding this helps illustrate the importance of adhering to the contribution limits set by the IRS to maximize the tax advantages of retirement savings.