Overcontributions to 401K - Follow up questions

[JimFisher]

Hello, 

I read different posts about over contributions to 401K. So, I am aware of certain action items but have some follow up questions

Context is that I was with employer A till March ending (worked there for 10 years) and started with a new employer B in May. So, I was aware that I made some 401K contributions till March. However, In April, my old employer A paid off left over PTO and bonus and I did not realize until now that 401K was cut from there as well. Due to the 10 year PTO and fiscal year bonus is paid at the end of March, I ended up contributing a lot more to the 401K via employer A that I did not account for.. 

I am aware that I can correct this by calling employer or plan admins

1. I want to request my plan admin for employer A to return the over contributions. Are they obligated to do that or can they tell me to go deal with my current employer B? I prefer requesting employer A because I had a higher match from current employer B.
2. If they return, will they take away the employer A matching contributions?
3. Lets say I over contributed by 5000 and the market went down by 20%. Will they give me back 4000 or 5000
4. If they issue 4000, can I claim capital gains loss of $1000?
5. Will they issue 1099-R in such a way that I dont have to pay penalty on these but pay taxes?

thanks

JimF

[Critter-3]

FIRST ... IMMEDIATELY contact employer A and see if they can or will remove the excess contribution.  If they can't or won't then contact employer B since this must be done ASAP.  Until you know who will do what the rest is immaterial.

[dmertz]

1. Neither employer is required to return the excess contributions.
2. If either employer does return the excess contribution you would also lose any matching contributions attributable to the returned contributions.
3. They give you back $4,000, the gain/loss adjusted amount.
4. No.  An attributable loss would not be a capital loss.  You cannot claim a deduction for the loss.
5. The coding of the Form 1099-R will indicate that there is no penalty.

You could consider leaving the excess contribution in and just report it as taxable income on your 2022 tax return.  The funds will then be taxable a second time when eventually distributed because paying the taxes on an excess contribution left in does not cause the excess contribution to become after-tax basis in the 401(k).

[JimFisher]

@dmertz the plan admin from the first employer asked me to submit a letter so that they can process. I will let you know how things go.. 

>>>
You could consider leaving the excess contribution in and just report it as taxable income on your 2022 tax return. 

Does IRS require us to report the over paid contributions as taxable income in this year? If I were to pursue this option, I am guessing I have to report the employee part of the excess contribution as taxable income. correct? 

Leaving the contributions (employee + employer) in a down market time and for few years may actually end up being net positive at retirement even if I have to pay taxes.. 

[dmertz]

"Does IRS require us to report the over paid contributions as taxable income in this year? If I were to pursue this option, I am guessing I have to report the employee part of the excess contribution as taxable income. correct?"

Yes, you would enter it into 2022 TurboTax as Miscellaneous Income -> Other income not already reported on a Form W-2 or From 1099.

[Critter-3]

Yes and all you do is enter the W-2 forms as printed then the program will compute the excess and deal with it for you ... nothing more you need to do.  

[dmertz]

TurboTax will flag an excess elective deferral but will not automatically treat it as taxable income.  To treat it as taxable it must be entered as I described.

[JimFisher]

Very cool. Request made with the Plan Admin of Employer A.  They were open to return. Lets see what happens

[JimFisher]

@dmertz The first employer is not returning the money saying that they follow last in first out.  They are saying that the limit was met with your current employer and you should request that employer.  The second employer has 50% contribution matching and I do not want to lose that. 

So are my options now to get the amount refunded from the current employer or pay taxes for above the limit now and when the funds are withdrawn in retirement?

[MichaelG81]

It depends, if you take out your excess contribution(s) before April 15, 2023 you should be able to avoid the excess penalty. TurboTax will calculate your excess contribution. That is the amount that must be taken out including gains, and if no gains you must take the full excess contribution amount out before April 15, 2023. No capital gains loss on 401k, since tax treatment is different when withdrawing tax deferred savings or a retirement plan. When you start withdrawing your basis and gain may be taxable if these were tax deferred contribution(s), based on current guidance.

If the total of a plan participant's elective deferrals exceeds the limit under IRC Section 402(g), to avoid failing IRC Section 401(a)(30), the excess amount plus allocable earnings must be distributed to the participant by April 15 of the year following the year of deferral. Excess deferrals not timely returned to the participant are subject to additional tax.

Timely withdrawal of excess contributions by April 15

• Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
• Earnings are taxable in the year they're distributed.
• There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.

@JimFisher

[dmertz]

@JimFisher , yes, those are your options.

[MichaelG81]

For matching questions; see how to take out your funds from your non-matching institutions, either by contacting your plans sponsor, employer, or HR for tax year 2022 if withdrawn by April 15, 2023. Remember, you are allowed up to $20,500 for tax year 2022, for 401(k) contributions, in addition to a catch-up contribution, if eligible, of $6,500. Remember, your employer match doesn't count toward this limit.

@JimFisher

[bunjey11]

I am in a similar position as @JimFisher 

Contributed $15k with Employer A, and then left to join employer B where I contributed the min to take advantage of the employer match and that added an additional $9k . In total I contributed $24k for 2022. Was aware of the situation the whole time (after I quit ER A, figured the 6% match ($9k) from employer B was worth more than the taxes on excess contributions. I was under the assumption that this can easily be handled upon filing my tax returns but seems more complex than that. 

Employer A refused to refund the excess and said it must be done by Employer B. Employer B is able to do it but I will lose the value of the Employer match ($3.5k as well). 

Given that I missed the April 15th deadline, what's the best option for me at this point. I filed an extension on my 2022 tax return until I figure this out. From a tax perspective whats more beneficial to me now:

1. Have employer B process the $3500 refund and reissue 2022 W2 (i lose the $3500 ER match)

2. Capture the $3500 as other income in my 2022 taxes and submit the return as outlined as one of the options earlier for Jim. 

3. What happens if I do nothing and submit the return, will system flag it as excess 401k contributions?

Thanks for your help. 

[dmertz]

1.  Too late for that to be of any benefit.  The employer cannot change the W-2.  Getting a distribution of the $3,500 would not only cause you to lose the match, the $3,500 would still be double-taxed.

2.  This is the only suitable option.

3.  TurboTax would flag the excess contribution, but ignoring that warnings failing to include the $3,500 in 2022 income would be underreporting 2022 income.