Overcontribution to 401k: Options to Correct?

[townie]

Hi Community,

I noticed that I over-contributed to my 2022 401k because of a change of employers. Let me please describe the details below, and I will appreciate your help in understanding my options. Already did not initial investigations, and I will share the details and links below. Hopefully it will be helpful for both, helping my to find a good solution and helping others with similar questions. 🙂
To help structure the responses, I will mark my key questions in red.

At my first employer in 2022, I made the following 401k contributions:

    Pre-tax: $16,400.00

    Roth:    $4,100.00

   (Total:   $20,500.0)

At my second employer:

    Employer Match:       just under $10,000

    After-Tax (Backdoor): approx $5,000

    Pre-Tax:              $632.70

    Roth:                 $12,925.02

Q1.a:( My understanding that the amount in the second 401k that counts towards the $20,500 IRS limit is $632.70 + $12,925.02 = $13,557.72, and the employer-match and backdoor contributions are not relevant, correct?

Q2.b) Since the first 401k was already maxed out, the $13,557.72 is exactly the overall over-contributed amount in 2022, correct?

Assuming the above is correct, I am now trying to understand the best course of action.

I've already done some investigating:

- 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, 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). If I understand correctly (validating this understanding is my Q3), if the money is withdrawn before the tax deadline, then I can avoid double taxation. In that case the money would need to be taxed as 2022 W2 income, and the early withdrawal penalty would be avoided. Correct?

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.

Q4) My next step is to understand what the applicable tax 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 (see section "Excess Contributions Withdrawn by Due Date of Return"). (I have filed for the tax extension.)

Which deadline applies will probably determine my next steps:

- (Q5.a) If it passed, I will need to understand the consequences of withdrawing the over-contributed amount now vs. later.

- (Q5.b) 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]

The way section 402A(c)(2) of the tax code is written, the excess of $13,557.72 is deemed to be in the designated Roth accounts.  This means that $632.70 of Roth IRA contributions at the first employer and all of the Roth contributions at the second employer are excess contributions.

https://www.law.cornell.edu/uscode/text/26/402A

The tax code specifies the deadline to receive any corrective distributions of excess employee deferrals or Roth contributions from a 401(k) as being April 15 of the following year, not the tax deadline, although they are generally the same (except when the tax deadline gets extended).  The reference in IRS Pub 590-A applies to IRAs, not to 401(k)s.  See IRS Pub 560 for rules for qualified retirement plans.

The consequence is that distributions from the designated Roth accounts are taxable to the extent of the excess contributions and attributable earnings until these amounts are fully distributed.  The result is double taxation of the excess and single taxation of the earnings.  You won't be able to take distributions from the plan at your new employer until you either separate from service or reach age 59½.  You can take distributions from the designated Roth account at the first employer since you have separated from service, but it would be as a regular distribution and, with the excess and attributable earnings being taxable, they would also be subject to a 10% early-distribution penalty.  It's likely that the first employer's plan would not  report such a distribution as taxable, so you would probably have to file a substitute Form 1099-R to report the distribution as taxable.