First Person: What Happens If I Over-Contribute to My 401(k)?

If you're like most employees, you really don't think about your 401(k) plan at work after you first set it up. If you stay with one employer for the entire year, you likely don't have to look at it too often. However, if you start a new job and have to set up a new 401(k) plan, you may run the risk of over-contributing to the plan. I see this quite frequently in my accounting practice, but there is an easy fix- as long as you catch the error soon enough.

How Much Trouble Am I In?

The good thing about over-contributing to a 401(k) plan is that there is no penalty for the excess. However, if you do nothing about it, you will be double-taxed on the amount of the contribution. You will be required to report the excess as income on your return in the year you made the contribution. You will also be taxed again on the contribution when you withdraw it in retirement. That is a significant downside to not paying attention to your limits.

However, if you withdraw the excess before April 15th of the following year, you will not be subject to this tax. Once that date has passed, you no longer have the option to correct the over-contribution.

Should I Take Out the Excess?

The absolute best way to handle 401(k) over-contributions is to ask your plan administrator to do a corrective distribution before April 15th of the following year. This corrective distribution allows you to take out the excess along with any investment income that excess created. You will receive a tax form for the distribution (1099-R) and will include the contribution in your taxable income. This has the effect of canceling out the deduction you are also reporting for the excess contribution on the W-2 from your employer.

Employer-Matched Plans

What happens if your employer matched some of your over-contributions? Do you have to take that money out of the plan too? The answer is "rarely". Employer contributions have to follow some limits and, as long as they are still within those limits, the money can stay in the plans. Also, the total of all contributions (both employee and employer) cannot be more than the lesser of the employee's salary or $49,000. As long as those limits aren't breached, you do not have to take any action on the employer contributions to the 401(k).

How Can I Ensure That it Doesn't Happen Again?

If you have more than one employer during the year, you must track your own 401(k) contributions to make sure that you do not over-contribute during the year. Take the maximum contributions ($16,500 in 2011) and subtract what you have already put in during the year. Divide that remaining contribution room by the number of pay periods left in the year. This is the maximum amount you should tell your plan administrator to contribute to your new 401(k) plan.

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