What to Do If You Over-Contribute to Your 401(k) Plan
Contributing to a 401(k) plan is a smart way to save for retirement. It allows you to take advantage of tax benefits and grow your savings over time. However, there may be instances where you accidentally over-contribute to your 401(k) plan. If this happens, it’s important to take action and notify your employer or plan administrator as soon as possible.
Understanding Excess Deferrals
An excess deferral occurs when you contribute more money to your 401(k) plan than the annual contribution limit set by the Internal Revenue Service (IRS). As of 2021, the annual contribution limit for a 401(k) plan is $19,500 for individuals under the age of 50 and $26,000 for individuals aged 50 and older.
If you exceed these limits, the excess amount is considered an excess deferral. It’s crucial to address this issue promptly to avoid potential penalties and tax implications.
Notify Your Employer or Plan Administrator
If you realize that you have over-contributed to your 401(k) plan, the first step is to notify your employer or plan administrator. It’s essential to do this by March 1 of the year following the excess deferral. By notifying them within this timeframe, you can avoid additional taxes and penalties.
Contact your human resources department or the designated person responsible for managing the company’s retirement plans. Provide them with the necessary information, including the excess amount and the date it was contributed. They will guide you through the process of correcting the excess deferral.
Correcting Excess Deferrals
There are two ways to correct excess deferrals: distributing the excess amount or requesting a return of the excess amount.
1. Distributing the Excess Amount
If you choose to distribute the excess amount, it must be done by April 15 of the year following the excess deferral. This means you have until the tax filing deadline to correct the over-contribution.
The excess amount will be included in your taxable income for the year it was contributed. You will receive a Form 1099-R from your plan administrator, which you must report on your tax return. Additionally, you may be subject to a 10% early withdrawal penalty if you are under the age of 59 ½.
2. Requesting a Return of the Excess Amount
If you prefer to request a return of the excess amount, you must do so before the due date of your tax return, including extensions. The excess amount will be returned to you, and it will not be included in your taxable income for the year.
However, any earnings generated from the excess amount will be subject to income tax and a 10% early withdrawal penalty if you are under 59 ½. It’s important to consult with a tax professional to understand the potential tax implications of this option.
Preventing Future Excess Deferrals
To avoid over-contributing to your 401(k) plan in the future, it’s essential to stay informed about the annual contribution limits set by the IRS. Regularly review your contributions and ensure they do not exceed these limits.
If you have multiple employers or participate in multiple retirement plans, make sure to coordinate your contributions to stay within the overall annual limit. Keep track of your contributions throughout the year and adjust them accordingly to avoid any excess deferrals.
While over-contributing to your 401(k) plan can happen accidentally, it’s crucial to address the issue promptly to avoid potential penalties and tax implications. Notify your employer or plan administrator as soon as you realize the excess deferral and follow their guidance to correct the situation. By staying informed about contribution limits and monitoring your contributions, you can prevent future over-contributions and ensure your retirement savings stay on track.