By Ian Berger, JD
The amount of annual elective deferrals you can make to a 401(k) or 403(b) plan is limited by the tax code. If you discover that you’ve over-contributed in 2019, time is of the essence to correct the error. If you don’t act quickly, the tax consequences are serious.
What is the limit? For 2019, you were limited to $19,000 in elective deferrals (plus an additional $6,000 if you were at least age 50 at the end of the year). It’s important to remember your deferrals to each company savings plan are normally aggregated for purposes of this limit. (There is an exception if you participate in both a 457(b) plan and a 403(b) plan.)
How do you know whether you’ve exceeded the limit? Most plans have mechanisms in place to prevent you from exceeding the deferral limit in that plan. The problem normally arises if you participated in two different plans during the year (for example, you changed jobs). The W-2 you received from each employer should indicate the amount of elective deferrals in Box 12. Or, you can check your plan statement.
What do I do if I’ve exceeded the limit? Don’t panic, but contact your plan administrator as soon as possible. To avoid double taxation (see below), the plan must correct the excess amount by April 15, 2020. Since correction may take some time, it’s important that you do this quickly. If you don’t know how to reach the plan administrator, contact your company’s HR department.
What happens next? The plan must make a “corrective distribution” of the excess amount – adjusted for earnings or losses on the excess. The earnings or losses cover the period between the date the excess deferral was made and December 31, 2019. You will receive a corrected W-2 that adds back the excess deferrals to your 2019 taxable wages. Earnings on the excess are taxable to you in 2020.
Example: Hannah, age 40, made pre-tax elective deferrals of $10,000 to Company A’s 401(k) plan before she left Company A to join Company B on July 1, 2019. Hannah then made another $10,000 of pre-tax deferrals to Company B’s 401(k) between July 1 and December 31, 2019. She has exceeded the 2019 deferral limit by $1,000. The excess $1,000 of deferrals earned $75. Hannah becomes aware of this problem and immediately contacts the administrator of Company B’s plan.
Before April 15, 2020, the plan makes a corrective distribution of $1,075 to Hannah. Company B also sends Hannah a corrected 2019 W-2 showing an additional $1,000 of 2019 taxable income. She must include the $75 as taxable income for 2020.
What if the April 15 deadline is missed? This definitely creates double trouble. The excess deferrals are taxed to you both in the year they are contributed and in the year they are eventually paid out.
What if I make excess deferrals in a 457(b) plan? The rules for correcting 457(b) excess deferrals are different than those described in this article. Contact your plan administrator for more details.