Excess Contribution to both 401K and 401Roth

[TheGuttes]

Here is my problem. My wife had two different employers in 2023. Both contributed $22,500 to a combination of traditional 401K and Roth 401K.  We confirmed this only after we filed our taxes (turbotax did give the notice) and after April 15th, 2024. 

What do we do now?  As I understand it, we need to figure out how much was contributed to the traditional 401K and pay tax on that amount plus earnings on those contribution. (No idea how I would calculate that? Is there still a 6% penalty as well?). Then we can leave the traditional 401K contribution in the retirement fund. For the Roth 401K presumably we have to remove the contribution, but neither the employer nor the plan manager (Vanguard) seems willing to do that.

Any help would be much appreciated!  (I can't believe this does not happen to a lot of folks).

Thanks!!!!

[dmertz · Accepted solution]

I assume that you meant to say that your wife (not the employer) contributed $22,500 for 2023 at both employers.

"As I understand it, we need to figure out how much was contributed to the traditional 401K and pay tax on that amount plus earnings on those contribution."

Only the amount of the excess traditional 401(k) contribution is to be added to 2023 AGI, not the attributable earnings.

Because it is now after April 15, 2024, distributions of the excess employee contributions would have to be done by regular distributions which are not permitted (except as hardship distributions) until age 59½ or separation from service.  The excess traditional and Roth contributions and attributable earnings will be taxable when eventually distributed.  This means that there will be double taxation of the $22,500 total of excess contributions to the traditional and Roth accounts and single taxation of the attributable earnings from both.  If the distribution is obtained before age 59½, there will generally also be a 10% early distribution penalty on the amount distributed.

[Mike9241]

your situation raises the question as to whether or not you are covered by Tutbotax accuracy guarantee. It did not flag the excess. I tried a similar situation in desktop version and there was no flag that there was an excess so it's not that you made the error.

as stated, no guarantee, but you may want to file a claim

 https://ttlc.intuit.com/turbotax-support/en-us/help-article/intuit-account-billing/submit-claim-turb... 

[Opus 17]

@dmertz 

Can you explain more with respect to the excess contributions to the designated Roth?  They are already taxed, and they won't be taxed on withdrawal, so it seems there is no consequence or penalty for excess deferrals to a Roth 401k?  

[dmertz]

Double-taxation is effectively the penalty that you pay for the excess employee contribution whether the excess contribution is made to the traditional account or to the Roth account.

Treasury Decision 9324, Internal Revenue Service, 2007-22 I.R.B. 1302 states:

Designated Roth Contributions as Excess Deferrals

Even though designated Roth contributions are not excluded from income when contributed, they are treated as elective deferrals for purposes of section 402(g). Thus, to the extent total elective deferrals for the year exceed the section 402(g) limit for the year, the excess amount can be distributed by April 15th of the year following the year of the excess without adverse tax consequences. However, if such excess deferrals are not distributed by April 15th of the year following the year of the excess, these final regulations, like the proposed regulations, provide that any distribution attributable to an excess deferral that is a designated Roth contribution is includible in gross income (with no exclusion from income for amounts attributable to basis under section 72) and is not eligible for rollover. These regulations provide that if there are any excess deferrals that are designated Roth contributions that are not corrected prior to April 15th of the year following the excess, the first amounts distributed from the designated Roth account are treated as distributions of excess deferrals and earnings until the full amount of those excess deferrals (and attributable earnings) are distributed.

[Opus 17]

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@dmertz wrote:

Double-taxation is effectively the penalty that you pay for the excess employee contribution whether the excess contribution is made to the traditional account or to the Roth account.

Treasury Decision 9324, Internal Revenue Service, 2007-22 I.R.B. 1302 states:

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Thanks.  So the taxpayer would be required to keep track of their excess deferral until they retire, and then voluntarily declare that the first dollars withdrawn from the Roth 401K are taxable, until the excess deferral and attributed earnings are used up (distributed).  The 401k plan custodian won't know about this issue, and while the IRS has the information available to them (via the W-2s), it seems unlikely that they will actually track the issue for 20 or 30 years.  It seems to be entirely voluntary.

In this situation, it would be easier for the taxpayer to take the position that all the excess deferral is attributed to the pre-tax accounts, and declare that on their tax return as taxable other earned income on line 1h (or on an amended return) and pay the tax.  That way there would be no excess in the Roth account and nothing to keep track of. 

[dmertz]

Section 402(c)(2) of the tax code effectively allocates the employee's excess contributions first to the designated Roth contributions, eliminating the possibility of allocating the excess first to the pre-tax contributions.

[TheGuttes]

Thank you all.  Let me make sure that I understand what this means on a practical basis.  First, I have to amend my taxes to reflect that amounts contributed to my 401(K) above the $22,500 level are taxable income. Second, I can (and probably should) withdraw the excess contributions to the Roth, because they are no longer entitled to the sheltering of earnings they otherwise would have received on distribution.

[Mike9241]

@TheGuttes . i believe you have the option to withdraw the excess from either the traditional IRA or Roth 401(k) 

This comes down to in part what's best from a tax standpoint and part a personal decision. 

taking it out of the traditional will increase your taxable income for the year contributed by the amount removed and if taken out after the due date is taxed twice. first in the year contributed because it's not allowed and 2nd in the year withdrawn as a distribution 

see this about removal of ROTH contributions if account has not been in existence for 5 years

https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts#Distributions 

what's best is unknown. you need to sit down with a tax pro to analyze your situation.    

[Opus 17]

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@TheGuttes wrote:

Thank you all.  Let me make sure that I understand what this means on a practical basis.  First, I have to amend my taxes to reflect that amounts contributed to my 401(K) above the $22,500 level are taxable income. Second, I can (and probably should) withdraw the excess contributions to the Roth, because they are no longer entitled to the sheltering of earnings they otherwise would have received on distribution.

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Yes and no.  Please read the replies from @dmertz .

[Edited for correction]

Yes, you must report the excess deferrals to the pre-tax 401k as taxable income.  However, you do not report excess deferrals to the Roth 401k as taxable income.  If possible, depending on the amount contributed to each account, you must allocate the excess deferrals to the pre-tax account.

If you can allocate all the excess deferrals to the pre-tax account, and you amend your return, you are done.  You can't use the special procedure to remove excess deferrals after April 15.  You simple pay income tax on the withdrawals when you retire, even though the excess was also taxed in 2023.  Leave the Roth 401k alone.

If you can't allocate the excess all to the pre-tax account, so you have some excess in the Roth, this creates a bit of a problem.  For example, suppose your wife contributed a total of $30,000 to the Roth account and $15,000 to the pre-tax account.  You would report $15,000 of additional taxable income.  That leaves her with an excess deferral of $7,500 in the Roth account.  What that means is that, whenever she withdraws from the Roth 401k, the first $7500 (plus attributable earnings) are taxable.  She could withdraw the money now, but probably only from the former employer and not the current employer (because you generally can't withdraw money from the account with a current employer except for a financial hardship as defined by their plan.  You can withdraw from a former employer after separation of service.)  Or she can wait and withdraw the money later, but she needs to keep track of any excess and any attributable earnings. 

[dmertz]

You said that your wife had two different employers in 2023, but did not say if she is still employed by either or both.  Distributions of the excess and attributable earnings after April 15 would be regular distributions subject to all of the normal regulations for distributions.  This includes the statutory prohibition on distributions of employee contributions before age 59½ or separation from service.  Unless one of these events occurs (or has occurred), the excess employee contributions must remain in the 401(k).

[Opus 17]

I want to clarify one more thing that I noticed.

"My wife had two different employers in 2023. Both contributed $22,500 to a combination of traditional 401K and Roth 401K."

Are you saying that the total contribution plus employer match was more than $22,500, or are you saying that your wife's voluntary deferrals are more than $22,500?

The total allowable contribution to a 401k including both elective deferrals and employer match is $66,000 for 2023.  If the employer contributions were more than $22,500, that's ok as long as they are not more than $66,000 combined.  The $22,500 limit only applies to the elective salary deferrals (your wife's contributions). 

[TheGuttes]

Just to clarify so the record is complete.  She maxed out her personal contribution of $22,500 at each company. At each company she reached her personal max with a combination of contributions to her 401(K) and Roth.  She is still at the second company, but has left the first company. If I understand where we are, this means she could (and probably should) transfer the Roth from the first company to a regular after tax saving account, because there is no benefit in leaving that money in the Roth and she can do this because she no longer works at the first company.

Thanks again!

[dmertz]

"If I understand where we are, this means she could (and probably should) transfer the Roth from the first company to a regular after tax saving account, because there is no benefit in leaving that money in the Roth and she can do this because she no longer works at the first company."

Only with respect to the excess (Roth elective contribution for 2023) and attributable income.  Anything else that might be in the Roth 401(k) at the first company can remain or be rolled over to another Roth account.  Because the plan will issue a Form 1099-R showing the distribution as a regular distribution of a mix of nontaxable basis and taxable gains, an explanation would need to be included with the tax return for the year of this distribution showing why the entire amount is taxable, probably by submitting a substitute Form 1099-R (Form 4852).  One thing I'm not sure about is whether this amount is subject to an early distribution penalty.  If so, because the entire amount is taxable, it would seem that the entire amount would be subject to the 10% early-distribution penalty if distributed before age 59½.  However, given that such a distribution from the traditional 401(k) account would be subject to this penalty, I believe that the same is true for such a distribution from the designated Roth account.

[Opus 17]

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@TheGuttes wrote:

Just to clarify so the record is complete.  She maxed out her personal contribution of $22,500 at each company. At each company she reached her personal max with a combination of contributions to her 401(K) and Roth.  She is still at the second company, but has left the first company. If I understand where we are, this means she could (and probably should) transfer the Roth from the first company to a regular after tax saving account, because there is no benefit in leaving that money in the Roth and she can do this because she no longer works at the first company.

Thanks again!

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This is far beyond what you need to do.

Note also that unqualified withdrawals (the account is less than 5 years old or the account holder is under age 59-1/2) are subject to income tax and a 10% penalty on the earnings.  

The only thing you need to do is withdraw the excess contribution, plus the attributed earnings.  You do not need to withdraw the whole amount, unless the only contributions in that account are excess earnings.  There is certainly much value in having retirement funds that will be tax-free.  

The only thing you need to do is add up the amount of Roth contributions to both employers, and withdraw that amount from the Roth 401k at employer A, plus the attributable earnings.  Both the contribution and the earnings are subject to income tax, and the earnings may be subject to a 10% penalty.  You can leave the rest of the 401k alone.

You do have the option of withdrawing the entire amount.  In that case, expect to pay income tax plus a 10% penalty on any earnings, and income tax on the excess deferral (excess contribution) but any allowable contributions will be tax-free.