I have made excess 401k deferral in 2023 and it was recently rolled over into an IRA. What is the procedure to rectify the excess contribution?

[vsouvalian]

In year 2023 I made excess 401k deferral that was recently rolled over into an IRA since I left my company. Unfortunately I found out this recently while filing my taxes with turbo tax. How can I fix the situation?   I did contact the company that handled my 401k and it is the same company that handles my 401k and I did not get any satisfying answers, since the complexity comes from the rollover.

[DanaB27]

You must include the excess deferral in your wages in the year the excess deferral happened. 

1. Login to your TurboTax Account 
2. Click "Federal" from the left side of your screen
3. Scroll down to "Less Common Income" and click "Show More"
4. Scroll down to "Miscellaneous Income, 1099-A, 1099-C" and click "Start"
5. Select "Other income not already reported on a Form W-2 or Form 1099" and click "Start"
6. On the "Did you receive any other wages?" screen answer "Yes" and click "Continue"
7. Continue until you get to the "Any other earned income" screen, answer "Yes" and click "Continue"
8. On the "Enter Source of Other Earned income" screen select "Other" and click "Continue"
9. On the "Any Other Earned Income" screen enter "2023 Excess 401(k) Deferrals" for the description, enter the amount and click "Done".

Generally, if you do not take out the excess amount by April 15th, then you are taxed twice on the excess deferral left in the plan.  This happens once when you contribute it and again when you receive it as a distribution. You can't include the excess amount in the cost of the contract even though you included it in your income.

[Opus 17]

I want @dmertz  to review this.

The first step is that the excess deferral is reported as taxable income.  That's correct so far.

The normal second step is to remove the excess contribution.  That way you can spend it or invest it someplace else since it is taxable income and not tax-deferred.  If you leave the excess in the 401k, you will pay income tax when you withdraw the money, meaning you pay tax on those dollars twice.   However, because you rolled the funds over from a 401k to an IRA, I suspect you lost the ability to withdraw the excess (even though the accounts are with the same administrator).  I think you pay tax on the excess contribution now, but you can't withdraw the excess from the IRA, meaning that when you withdraw it in retirement, you will be taxed again on the same money. 

[dmertz]

How did the excess deferral come about?  If only one employer was involved, the plan should have rejected any attempt to make an excess deferral.

My first thought was that you could treat the distribution from the 401(k) as having included an amount that was ineligible for rollover and that you could obtain a return of excess contribution from the traditional IRA.  However, after reading Opus 17' s reply, I think my first thought was wrong.  An excess deferral did not create and amount that was ineligible for rollover and, with no money in the 401(k) now, you are simply unable to request a return of that excess deferral.

The only potential way I can think of to avoid double taxation would be to roll some amount back into the 401(k) to be able to obtain the corrective distribution, but, even if that's possible, I think that that would be fraught with danger.  If the amount of the excess deferral is small, I think I would just include the excess in income on your 2023 tax return and be done with it.  Yes, it will eventually get taxed again when distributed from the traditional IRA, but if the excess deferral is small, that would be the safe thing to do.

[vsouvalian]

Turbo Tax shows me how to do what you are referring to.  The problem at hand is determining the deferral amount gain during this time since its not just the excess deferral that has to be accounted for but the gain as well. The initial gain is from my 401K and additional gain or loss when it was rolled over. I want to report both gain and excess deferral.

[Opus 17]

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@vsouvalian wrote:

Turbo Tax shows me how to do what you are referring to.  The problem at hand is determining the deferral amount gain during this time since its not just the excess deferral that has to be accounted for but the gain as well. The initial gain is from my 401K and additional gain or loss when it was rolled over. I want to report both gain and excess deferral.

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I'm not sure that you are on the right track.  As far as we (me and @dmertz  agree), you can't do a corrective distribution unless you can somehow roll money back into the 401k from the IRA.  If you are able to do that, then you must roll back enough to remove the excess contributions and the earnings.  Calculate  the earnings only based on how long the money was in the 401k, don't count the time it was in the IRA.

However, if you can't roll back the money and do a corrective distribution, then you leave all the money in the IRA and pay tax whenever you withdraw it.  You must also add the amount of the excess deferral back to your taxable income.  However, the amount of the add-back that you pay tax on is only the excess deferral and not the earnings. 

[vsouvalian]

My response was to a different post then OPUS 17. However when you do excess deferral to 401K you have to pay taxes on the amount plus any gain acquired or else you pay hefty penalties(6% for every year the money stays in your account). If you keep the money in the roll over during withdrawal you will be taxed again. I have reached out to the account administrator and there is a form you can file to remove the excess contribution from IRA and all this has to be done before filing your taxes.