By Ian Berger, JD
The amount of annual pre-tax deferrals and Roth contributions you can make to a 401(k) plan is limited by the tax code. If you exceeded that limit in 2021, time is of the essence to correct the error. If you don’t act quickly, the tax consequences can be serious.
For 2021, you were limited to $19,500 in pre-tax deferrals and Roth contributions (plus an additional $6,000 if you were at least age 50 at the end of the year). It’s important to remember that 2021 pre-tax deferrals and Roth contributions made to ALL plans are combined when applying this limit. (There is an exception if you participate in both a 401(k) plan and 457(b) plan.)
Most plans have mechanisms in place to prevent you from exceeding the deferral limit in that plan. If the plan mistakenly allows you to overcontribute, it is up to the plan to fix the problem.
It’s a different matter if you participated in two different plans during the year (because you had two jobs at the same time or changed jobs). One plan had no way of knowing how much you contributed to the other plan. So, it’s up to you to keep track. Your W-2 from each employer indicates the amount of pre-tax deferrals and Roth contributions in Box 12. Or, you can check your plan account statements.
If you’ve overcontributed, contact the administrator of one of the plans and make them aware of the problem. To avoid double taxation (see below), the error must be fixed by April 18, 2022. But act quickly to give the plan enough time to correct the error by that deadline.
The plan fixes the problem by making a “corrective distribution” to you. That is the excess amount, adjusted for earnings or losses on the excess. You’ll receive a corrected W-2 that adds back the excess deferrals to your 2021 taxable income. Earnings on the excess are taxable to you in 2022.
Example: Ray, age 40, had two jobs in 2021 and participated in each company’s 401(k). He made $10,000 of Roth contributions to the Alpha Company plan before leaving Alpha on June 30, 2021 to work for Beta Company. Ray did not keep track of his total 2021 contributions and made another $12,000 to the Beta 401(k) for a total 2021 contribution of $22,000. He has exceeded the 2021 deferral limit by $2,500 ($22,000 – $19,500). The excess deferrals earned $200. Ray becomes aware of this problem and contacts the administrator of Beta’s plan. On March 31, 2022, the Beta plan makes a corrective distribution of $2,700 ($2,500 + $200) to Ray. Beta also sends Ray a corrected 2021 W-2 showing an additional $2,500 of 2021 taxable income. He must include the $200 as taxable income for 2022.
If the corrective distribution is not made by April 18, 2022, you’ll face double trouble. The excess deferrals cannot be paid to you until you are otherwise able to receive a distribution from the plan. Nonetheless, they are taxed to you in the year they were contributed. And the excess, along with related earnings, is taxable a second time in the year it is eventually distributed to you.