So, you realized you contributed too much to your 401k. The good news is this can be remedied, but you will need to follow several steps and act quickly as there is a deadline before additional taxes may be due.
What is the annual 401k contribution limit?
The IRS sets the maximum allowable employee contribution to 401k plans annually. For 2021, this is set at $19,500 for those below age 50 and allow for an additional $6,500 catch-up contribution for those age 50 and older.
How did the over contribution occur?
Typically, if you are employed at the same job all year, your payroll department will automatically stop your contributions once you reach the allowable maximum. What happens if you change jobs mid-year, however? Mid-year job changes are the most common reason for over contributions to 401k plans. This is because the two employers, assuming they are unrelated, do not communicate how much you have contributed to your 401k during the year with one another.
For example, say you are age 40 and were employed at one position from January through April and contributed $8,000 to your 401k. In May, you changed jobs, and contributed $13,000 to your new 401k between your start date and the end up the year. In this scenario, you contributed $21,000 to 401k plans during the year which surpasses the annual maximum of $19,500. The result is an over contribution of $1,500 and the need for you to make a corrective distribution.
Another, less common reason, for over contributions is if you have two jobs that both allow for 401k contributions.
An over contribution occurred – now what?
Your first step will be to determine how much you over contributed to your 401k. It is very important to catch this quickly as the deadline to correct the issue is April 15th of the year following the over contribution. If this is not done, not only will you need to include the over contribution in income in the year of excess, but also in the year it is eventually corrected (you are taxed twice on the same income!).
Over contributions are most often caught when preparing your tax return. The W2s you receive from your employers will indicate how much you contributed to your 401k plan in Box 12, next to Code D. Review all W2s you personally receive and calculate the total amount contributed. Using the example above, your first W2 would show $8,000 contributed and your second W2 would show $13,000 contributed.
Next, you will need to contact your employer or plan administrator to notify them that an over contribution has occurred and inform them of the amount. The plan administrator will then distribute the over contribution plus any earnings attributed to the over contribution.
What does the over contribution mean for taxes?
Once the over contribution has been corrected, your employer should issue an amended W2. The amended W2 will show a reduced contribution amount in Box 12, Code D and an increase in taxable wages equal to the amount of the over contribution. This amended W2 can then be used to prepare your tax return.
Your plan administrator will also issue a 1099R. This form is for the portion of the corrective distribution that represents earnings. You will receive this form in the January following the year of the corrective distribution and will need to include on your tax return as ordinary income.
If the over contribution is not caught prior to filing your tax return, you will need to file an amended return.
Highlighting the importance of regular attention
If possible, it is best to catch this issue before it takes place. Periodically reviewing your year to date 401k contributions is not only a great way to make sure you are on track to maximize your contribution for the year, it can also prevent over contributions from occurring in the first place. Contact us if you have any questions about over contributing to your 401k.