The IRS is watching: Are you saving too much for retirement?

Many Americans don’t save enough for retirement, but it’s entirely possible to save too much — at least according to the IRS.

Tax laws limit how much you’re allowed to contribute to retirement accounts, and excess contributions can be penalized. Uncle Sam doesn’t want you to leave the money in the account too long, either. Those who fail to take enough out of their retirement accounts also face heavy penalties.

Here’s what you need to know to stay on the right side of the IRS’ rules.

Overstuffing your retirement accounts

Not everyone is allowed to contribute to retirement accounts. Contributions to an IRA or Roth IRArequire you or your spouse to have “earned income” such as wages, salary, bonuses, commissions, tips or self-employment income. Pension payments, Social Security benefits, rental income and interest and dividends don’t count. Also, the ability to contribute to a Roth phases out at modified adjusted gross incomes between $125,000 and $140,000 for single filers, from $198,000 to $208,000 for married couples filing jointly.

People may not realize that the annual limit on IRA contributions — $6,000 for 2021, plus a catch-up contribution of $1,000 for people 50 and over — is the cap for all IRA accounts. In other words, you can’t contribute $6,000 to a traditional IRA and another $6,000 to a Roth IRA in the same year.

You also can contribute too much to a workplace plan such as a 401(k), especially if you change jobs during the year. Your new employer won’t know if you’ve already made contributions to your previous employer’s plan that would count toward the annual limits (typically $19,500 for 2021, plus a $6,500 catch up contribution for people 50 and older), says tax expert Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting.

Even if you don’t change jobs, your 401(k) contributions could be capped if you’re deemed a “highly compensated employee.” That can happen if not enough lower-paid workers contribute and you own more than 5% of the company, earn more than a certain amount (currently $130,000) or are among the top 20% of employees ranked by compensation. Your excess contributions will be sent back to you as a check or other payment.

How to limit the damage

But usually it’s up to you to discover and fix an excess contribution. If you catch the problem soon enough — before you file your tax return for that year — you can limit the damage by withdrawing the excess contribution, says financial planner Robert Westley, a member of the American Institute of CPAs’ Financial Literacy Commission. You would also need to withdraw any earnings attributable to that contribution.