- Overcontributions to a 401k are called “excess deferrals” and must be fixed asap.
- If you correct the error before April 15 the following year, there are no penalties. Instead, the money gets returned to you, and gets added back to your taxable income in a new W-2 form.
- If you correct the error too late (after April 15 the following year), you’ll have to pay double taxes on the overcontributed amount. Once the year you overcontribute, and then again when you correct the error and withdraw the money. You may also have to pay an early-distribution penalty of 10%.
- To correct an overcontribution, first tell your employer or plan provider. They’ll refund you the money as a corrective distribution. If your excess defferral made any income while in your retirement account, that must also be returned to you. Then, file a new W-2 with the excess deferral and earnings added to your taxable income. Finally, use Form 1099-R to report the overcontribution to the IRS.
A 401k plan has yearly contribution limits. The 401k contribution limit for 2022 is $61,000 ($67,500 if age 50+). The limit for 2023 is $66,000 ($73,500 if age 50+).
The IRS sets these guidelines so that you can’t contribute more than the allowable amount in a tax-advantaged retirement plan.
An overcontribution is when you fund your 401k with more money than the allowable contribution limit.
Overcontribution to a 401k plan usually happen for the following reasons:
- When you switch jobs and move your 401k plan to another provider.
- When you have two jobs and miscalculate your contributions to each plan.
- When you get a substantial raise during the year, and contributions are automatically taken from a percentage of your paycheck.
401k plans don’t automatically block contributions when you go past the contribution limit. It’s up to you to calculate your contributions and make sure that you’re under or equal to the set limit for the year. If you accidentally overfund your 401k or solo 401k past the contribution limit, here’s what you need to do to.
Potential penalties for overcontributing to a 401k
Before we learn how to fix the problem, let’s first understand the potential penalties involved with overfunding a 401k or solo 401k.
Contributions made that are in excess of the contribution limit are called “excess deferrals” by the IRS. This amount must be reported and paid back to you by the federal tax filing date, April 15.
If it is not, the worst case scenario is you get taxed twice for the excess amount. You’ll pay taxes the year you overcontributed, and again the year you correct the error. Additionally, it could count as an early-distribution from your 401k if you withdraw the money too late, which also receives a 10% penalty on the amount of the overcontribution.
What to do if you overfunded your 401k.
If you realized you overcontributed to your 401k plan, here are the steps you need to follow.
Step 1: Contact your employer or plan administrator and inform them about the excess deferral.
Step 2: The plan administrator will return you the money as a corrective distribution. This is not instant, and some companies may take a long time to return you the funds. Make sure that you don’t leave this step to the last minute. It’s recommended that you report the error to your employer or plan administrator by at least March 1.
Step 3: Get a new W-2. The excess deferral that was returned to you now needs to be added to your taxable income for the year.
Step 4: If your excess deferral earned any money while in your 401k, you’ll also have to remove the earnings and count that towards your taxable income as well.
Step 5: Use form 1099-R to report it to the IRS.
The deadline to fix the error is April 15th, the following year.
If you remove the excess contributions from your account AND any income earned from the excess contributions by the federal tax deadline, you’ll avoid paying double taxes.
Also read: How To Fix Overcontributions to an IRA
The double tax explained
If you fail to fix the error by April 15 the following year, you’ll have to pay taxes twice on the excess contributions.
First, you’ll have to pay taxes for the year you contributed. Then, you’ll have to pay taxes when you fix the error and withdraw the excess deferral.
In some instances, you may also have to pay an early distribution penalty of 10% on the amount the year you withdraw the money.
When do I have to fix the error by?
You must withdraw your excess deferral by April 15th of the following year, which is the federal tax deadline of most years. Tax-filing extensions do not count towards fixing an overcontribution. You must fix the error by April 15, in order to avoid double taxation on the excess deferral.
Report the error to your employer or plan administrator by March 1
Most plan administrators set a March 1 deadline to report any excess deferrals. Even if your administrator does not have any deadline for reporting 401k overcontributions, you should still aim to report the error by March 1, anyways. Employers and plan administrators can be slow in fixing the error and returning you the money. Submitting it by March 1 ensures that you’ll have enough time to withdraw your excess deferral and refile your W-2.
What happens if I don’t do anything about it?
If you leave the money in your account and don’t make any effort to fix the error, your plan could become disqualified, and you would need to use the IRS Employee Plans Compliance Resolution System (EPCRS) in order to avoid plan disqualification.
How to fix overcontributions to a solo 401k
If you overcontributed to a solo 401k plan, the rules are slightly different for employee and employer contributions.
For employee overcontributions, you will need to report the error to your plan provider, who will help you withdraw the excess deferral and any earnings before April 15. The penalties, method of correction, and deadlines are the exact same as a 401k overcontribution.
For employer overcontributions, the funds will need to remain in your account and be carried over to the next tax year. A 10% fee will be applied to the overcontributed amount, which will need to be reported to the IRS by filing Form 5330.