401k Overcontribution: Options and Deadlines?

[townie]

Hi all,

(Note: My post was previously classified as Spam. I have no idea why. I will try rephrasing it and will try again.)

I noticed that in 2022 I over-contributed to my 401k because of a change of employers. Let me please describe the details below, and I will appreciate your help in understanding my options.
I am also including references to IRS publications that seem relevant for the community's benefit.

- I reached out to the first 401k account administrator and asked if contributions can be reversed, but they declined it citing administrative procedures.

- Reversing the second company's 401k contributions is pointless because even if it was possible, the second company did 401k-matcing. What I might gain in avoiding tax penalties, I'd lose by undoing the employer match, which would need to be reversed as well.

- I learned that I could withdraw the over-contributed amount (plus any capital gains) from any of the two accounts (I'd choose the first one since there was no employer match). Please, validate my understanding of the following:
-- If the money is withdrawn before the tax deadline, then I can avoid double taxation. In that case the over-contributed money would need to be taxed as 2022 W2 income, and the early withdrawal penalty would be avoided.
-- However, if I do this any time after the tax deadline, then the money (plus any capital gains) would be taxed as 2023 income (or whichever year I do the withdrawal) and I'd pay an additional 10% early withdrawal penalty.

Assuming this is correct, my next step is to understand what the applicable deadline is: several online forums imply that it has already passed on April/18. However, this IRS publication appears to say that the upcoming extended tax deadline is applicable:

"Publication 590-A (2022), Contributions to Individual Retirement Arrangements (IRAs)"
(Sorry, I included a link previously, but my post was classified as Spam. Please search for it. Search on page for the following subsection.)

Excess Contributions Withdrawn by Due Date of Return

You won’t have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw any interest or other income earned on the excess contribution. You must complete your withdrawal by the date your tax return for that year is due, including extensions.

(I have filed for the tax extension.)

Which deadline applies will probably determine my next steps:
- If it passed, I will need to understand the consequences of withdrawing the over-contributed amount now vs. later.
- If there is still time, I will need to understand how I can compute the exact amount to withdraw to correctly account for capital gains (they are actually small capital losses this year).

I am looking forward to learning more.

Thank you!

[dmertz · Accepted solution]

"-- If the money is withdrawn before the tax deadline, then I can avoid double taxation. In that case the over-contributed money would need to be taxed as 2022 W2 income, and the early withdrawal penalty would be avoided."

That statement is somewhat incorrect.  With regard to correcting an excess deferral, the statutory deadline was April 15, not the deadline for filing your tax return, so it's too late to obtain a return of the contribution.  You must now include the excess contribution in income (because it was excluded from the amount in box 1 of your Forms W-2) and it will simply be taxed again when eventually distributed as a regular distribution.  Enter the excess deferral into TurboTax under Wages& Income -> Less Common Income -> Miscellaneous income, 1099-A, 1099-C -> Other income not already reported on a Form W-2 or Form 1099, answer Yes to receiving other wages, proceed until you can answer Yes to earning other wages, select Other as the source of the other earned income, then enter the excess deferral.  TurboTax will include this on Form 1040 line 1h.

[townie]

Thank you, @dmertz and others.

I have a followup question.

My 401k has a Pre-Tax and a Roth parts. Can I freely decide how I split my over-contributions over those sub-accounts?

Let me make an example (rounding the numbers for simplicity).

I am picking one of my two 401k accounts to deal with the over-contributions. The total contributed to this account is $20.5K, consisting of $16.5K pre-tax and $4K Roth. My total over-contribution is $13K (because of a different 401k plan from a different employer).

Can I say that my $13K over-contribution consists of $9K pre-tax and 4K Roth?
If yes, do I see it correctly that for 2022's 1040 line 1h I only need to report $9K, because the other 4K are Roth, i.e. the tax has already been paid?

I understand that this is just the 2022 part and that all subsequent withdrawals will be taxed too. I am just focusing on the 2022 part separately to structure the conversation. 🙂

[dmertz]

A strict reading of section 402A(c)(2) of the tax code appears to deem the excess first to be in the Roth account and only the portion of the excess that exceeds the Roth contribution would be in the traditional account:

(2)Designation limits

The amount of elective deferrals which an employee may designate under paragraph (1) shall not exceed the excess (if any) of—
(A)the maximum amount of elective deferrals excludable from gross income of the employee for the taxable year (without regard to this section), over
(B)the aggregate amount of elective deferrals of the employee for the taxable year which the employee does not designate under paragraph (1).

In your example, this would mean that you have $4k of excess Roth contributions and $9k of traditional excess deferrals.  Only $9k would appear on Form 1040 line 1h.

[townie]

Thank you! 🙂

Ok, now I know how to correctly report the excess in the year it happened.

I would now like to understand about correctly reporting the withdrawal.

Q1) I understand from reading around the IRS site that since I missed the April deadline, I will pay income tax on all withdrawals, regardless whether it came from pre-tax or from Roth 401k. Is this correct?

Q2) I earned some bonuses at work and my tax bracket is quite high right now. I cannot see into the future, but I expect that it might be significantly lower in 3-4 years. So, I'd like to understand whether I can correctly adjust my 2022 tax using the 1040/1h method discussed above, but AVOID taking the excess distribution immediately. What if simply do not withdraw the money right now and keep it in my 401k?

In a few years, when my upper tax bracket is lower, THEN I take the withdrawal.

 - I read that for IRA there is an additional 6% penalty for doing this, but I cannot see it mentioned anywhere for 401k. Am I missing anything?

 - Is there anything wrong with doing it this way?

Thank you!

[dmertz]

A1)  When distributed, the excess and attributable earnings are taxable no matter which account they come from.  Be aware that if you roll one of these accounts over to an IRA, the first amount distributed consists of the excess and attributable earnings which are ineligible for rollover and, if inadvertently rolled over, become regular contributions to the IRA which are potentially excess contributions subject to annual 6% excess contribution penalties until corrected.

A2)  Once the April 15 deadline has passed, there is no further deadline for you to remove the excess and attributable earnings.  However, tracking the earnings attributable to the excess Roth contribution might get complicated.

The 6% penalty applies to excess IRA contributions, not to excess 401(k) contributions.