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HCE Excess Deferral 2020 Rolled Over to IRA Corrected in 2021
What Happened:
- During January through April 2020, and for several years prior, I was employed by XXX (as an employee), performing contract work for Collins Aerospace,
- While employed at XXX, I contributed to a 401K maintained by Voya. In those first few months of 2020 I was able to contribute what I thought was the maximum allowable to the 401K, approximately $24K (including catch-up allowance).
- After I left XXX, I transferred all of my savings from the Voya 401K to my rollover IRA account at Fidelity.
- Everything appeared to be fine when we filed our 2020 tax return in 2021.
- On December 2, 2021 I received an email from XXX stating...
- I need to let you know about some results of XXX’s 2020 401K plan testing and audit. All 401K plans go through annual testing to ensure compliance with ERISA laws that govern how certain retirement plans must be administered. One of the specific tests that takes place is ensuring that all employee classes are contributing to a plan in an equal manner. Unfortunately, due to the nature of our plan and workforce we have failed a specific test that affects you individually. Do not worry, this is not something you have done or could have expected to foresee. The specific test failed is the ADP (Actual Deferral Percentage) test which tests to make sure that the contributions made by non-highly compensated employees (NHCEs) are proportional to contributions by owners, managers or highly compensated employees (HCEs). Because you were classified as a Highly Compensated Employee (HCE) you have some excess contributions that cannot be applied to your 401K account as a result of this test failing. This amount will be returned to you by Voya within the next few weeks.
- However, as noted above, Voya did not have any money to return to me.
- After several emails back and forth, I learned that Voya was still required to document the excess contribution and that I had to pursue withdrawing the excess from my Fidelity rollover IRA.
- I contacted Fidelity, explained the situation, and filled out a special form that they have for these occurrences.
- I contacted Fidelity again later in December to resolve some issues with the form and got them to expedite the withdrawal.
- I felt that time was of the essence because it appeared that if I left the money there, additional penalties would be incurred.
- On December 28, 2021, Fidelity issued the withdrawal for me and also withheld federal and state taxes per my instructions.
- This withdrawal of approximately $12K was reflected in the total withdrawals for 2021 ($72K) on the 1099-R that I received from Fidelity in January 2021.
- In January 2021 Voya also sent me a corrected 2020 1099-R for the same withdrawal amount, showing no taxes withheld. They also issued a revised total withdrawal 2020 1099-R that was reduced by the same amount.
- Note that Voya did not have any funds to distribute at that time.
- So far, in preparing our tax return for 2021, I have included the $12K distribution by Fidelity in our calculations, as it was simply included in the total 1099-R that they sent me.
- When Fidelity issued this special distribution in December, they sent me an email stating that I would have to fill out a form 5329 and that I might also have to amend our 2020 tax return. Voya, in their parting letter on the subject, also mentioned a potential need for a revised 2020 return.
- We use Turbotax to prepare our returns, and I have found the 5329 form there, but I have questions.
Questions:
- Should the 5329 be submitted for the 2020 tax year, the 2021 tax year, or both?
- Which section of the 5329 applies? Is it Part III - Additional Tax on Excess Contributions to Traditional IRAs? There does not appear to be a section that applies to 401Ks
- If I must fill out the form for 2020, I assume that I will have to also submit a revised 2020 return. Is that correct?
- If I must submit the revised 2020 return and a 2020 5329, will I be charged twice for the taxes on the $12K withdrawal? ...once for the revised Voya 1099-R for 2020 that showed no withholding, and again on our 2021 return where the 1099-R from Fidelity included the actual withdrawal?
- I understand the need to pay taxes on the amount, but I don't believe I should be charged for that in both 2020 and 2021.
- Will I be subject to a 6% penalty because this excess amount was in my account for much of 2020 and 2021?
- Is there anything else that I need to know or any other actions that I need to take?
April 4, 2022
12:39 PM