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You did the right thing and maxed out your 401(k) contribution—only, you may have been a little overzealous and contributed more than allowed. Over-contributing to your employer's 401(k) or 403(b) plan can cause problems on your tax return and trigger additional taxes, a penalty tax and even double taxation.
Fixing the problem in time can help you avoid the worst of it. Here's how to spot the problem, understand potential taxes and penalties and get yourself back on track.
What Are the 401(k) Contribution Limits?
The IRS limits 2022 contributions to a 401(k) or 403(b) plan to $20,500. If you're age 50 or older, you can make an additional $6,500 catch-up contribution, bringing your total contribution to $27,000 each year. Contribution limits may change from year to year based on the cost of living.
These IRS contribution limits apply to both traditional and Roth 401(k) plans and do not include matching contributions from your employer. There are separate contribution limits that include employer matching dollars: Combined contributions from you and your employer can't exceed 100% of your salary or $61,000 ($67,000 if you're 50 or older) for the 2022 tax year.
What Are the Penalties for Excess 401(k) Contributions?
Your consequences for over-contributing to a 401(k) are different depending on when you catch the error and fix it. If you withdraw your excess contribution plus earnings before you file your taxes in April, you should not incur any penalties. As long as you report your wages correctly and pay any taxes due on your earnings (more on this later), you should be good to go.
If you don't fix your excess contributions by tax day, however, you will likely be on the hook for additional taxes. In fact, excess deferrals are subject to double taxation—that is, they're taxed in the year you contributed the money and again in the year when you withdraw the excess funds. Say you over-contributed $2,000 in 2022 but didn't catch your mistake until November 2023. You will owe taxes on an additional $2,000 on your 2022 taxes and—if you remove the excess contributions in November 2023—will owe taxes on the $2,000+ you withdraw in 2023 as well.
Excess contributions to Roth 401(k)s aren't double-taxed as just described. That's because you contribute to a Roth 401(k) using after-tax dollars. However, the excess funds you withdraw from a Roth 401(k) are taxable in the year you make the withdrawal.
You may also owe penalties for early withdrawal. Unless you are qualified to make penalty-free withdrawals from your retirement account, withdrawing your excess contributions could also trigger a 10% early distribution tax and 20% withholding. You may need spousal consent to make the withdrawal as well.
How Excess 401(k) Contributions Affect Your Taxes
Here's an example of how an overpayment might play out. Let's consider an accidental over-contribution of $2,000 to your employer's traditional 401(k) plan.
- If you (or your employer) catch the error before the year ends, your employer can return the $2,000 to you, along with any money your contribution has earned. Both the $2,000 and your earnings on that $2,000 will be taxable in the year the contribution was made. If you contribute to a Roth 401(k), your contribution is already included in your wages; no correction to your W-2 is needed. If you contribute to a traditional 401(k), your employer will need to add your contribution amount to your wages on your W-2. Make sure your W-2 and any 1099-R forms you receive from your employer are accurate before filing your taxes.
- If you catch the error the following year before tax day, your returned $2,000 contribution will be taxed as wages. Your employer will issue a corrected W-2 if necessary, which you can use when you file your taxes. Any money your contribution earns while it is in your account will be reported on a 1099-R in the current year, the year you withdraw the money.
- If tax day has already passed, you should still notify your employer and withdraw your excess contribution plus earnings on it as soon as possible. Your employer will issue a 1099-R reporting your excess deferral in the year you over-contributed. You'll need to file an amended tax return and pay any additional taxes owed. Additionally, you'll pay taxes on the withdrawal in the year you take it out, and you may owe a 10% early withdrawal penalty.
How to Fix Excess 401(k) Contributions
Keep an eye on your year-to-date contributions throughout the year. If you're approaching the contribution limit—or are on track to do so—talk to your employer or plan administrator immediately. Adjusting your contributions to stay within the limit is much easier than taking the actions below. If you do over-contribute, follow these steps to straighten out your account—and taxes.
- Notify your employer or plan administrator immediately. The sooner you can rectify the situation, the simpler and better the outcome. If your employer has notified you of an overpayment, act as soon as possible.
- Calculate your excess contributions plus earnings. Use this IRS formula for calculating your excess contribution plus "net income attributable" (the earnings your money made while it was in your account). Your plan administrator should do this calculation for you, but using this formula will help you estimate your earnings and double-check their numbers.
- Get an accurate W-2. Make sure your W-2 includes the excess contribution in your earnings. If your employer has previously issued a W-2, they'll need to issue a corrected form.
- File your return, or an amended return. If you've already filed your taxes for the year, you'll need to file an amended return.
- Add the excess contribution to your next return. If you withdrew your excess contribution after tax day, you'll need to be sure you include the distribution and/or earnings on it on your next year's return.
- Double-check your contributions going forward. You don't want to go through this again, so make sure you're on track to contribute the correct amount. You may need to make adjustments if you got a raise but didn't adjust your contribution percentage, you contribute to more than one 401(k) or you've recently turned 50.
The Bottom Line
Making the most of your employer's retirement plan is a good idea, just make sure you're contributing no more than allowed by the IRS. If you do contribute too much, the sooner you can reverse your excess contribution (plus earnings), the fewer consequences you're likely to endure.