Excess 401k Contributions With Two Employers: What You Need to Know

Managing retirement savings is essential for financial security, and 401k plans are a popular choice among employees. However, navigating contribution limits can be challenging, especially when juggling multiple employers in a single year. Excess contributions can have significant repercussions if not addressed promptly.

Understanding 401k Contribution Limits

For 2024, the IRS has set the annual contribution limit for employees at $23,000, an increase from previous years due to inflation adjustments. This cap applies to the total amount an individual can contribute across all 401k plans, including both pre-tax and Roth contributions, regardless of the number of employers. Employers may also contribute through matching or profit-sharing, but these amounts are subject to a separate overall limit of $66,000 or 100% of an employee’s compensation, whichever is lower.

For employees aged 50 and above, an additional $7,500 in “catch-up” contributions is permitted, raising the total potential contribution to $30,500 in 2024. This provision allows older employees to boost their retirement savings if they started saving later in their careers.

Consequences of Excess Contributions

Exceeding 401k contribution limits can result in double taxation. Excess contributions are taxed in the year of contribution and again upon withdrawal, eliminating the tax deferral benefits that make 401k plans attractive. Additionally, administrative challenges arise as employers must correct payroll records and tax filings.

The IRS requires excess contributions to be withdrawn by April 15 of the following year to avoid a 6% excise tax, which applies annually until corrected. This penalty underscores the importance of addressing overages promptly.

Identifying Excess Contributions

Detecting excess contributions involves closely monitoring your financial transactions. Regularly review pay stubs and annual contribution statements to identify discrepancies. This is especially critical if you switched employers during the year, as each employer may not be aware of your total contributions.

Online tools and calculators from financial institutions can help forecast year-end contributions. Consulting a financial advisor ensures contributions align with your goals while staying within legal limits. Be cautious about timing contributions, such as allocating a year-end bonus to your 401k, as this could inadvertently exceed the limit. Employers typically do not track cumulative contributions across multiple plans, so employees must take responsibility for compliance. Keeping detailed records of all contributions is essential.

Steps to Correct Excess Contributions

If you discover excess contributions, notify your plan administrator immediately. They will require documentation of your total contributions and may provide forms to facilitate the correction process. The administrator will initiate a corrective distribution, withdrawing the excess amount and any associated earnings from your 401k account.

The withdrawn earnings are taxable in the year they are distributed, which may affect your tax liability. A tax advisor can help you understand the implications and adjust your tax withholding or estimated payments accordingly. Correcting excess contributions promptly ensures compliance and avoids further penalties.

Tax Implications of Excess Contributions

The IRS treats excess contributions and associated earnings as taxable income in the year they are distributed. If the corrective distribution occurs in 2024, the excess must be reported as income on your 2024 tax return. While the earnings are taxable, they are exempt from the 10% early withdrawal penalty if corrected within the IRS’s timeframe.

Strategic planning can help mitigate the tax burden. Adjusting tax withholding or making estimated payments can offset the impact of additional taxable income. Consulting a tax advisor ensures accurate reporting and completion of required forms, such as IRS Form 1099-R, which details the distribution of excess contributions.

Strategies to Avoid Excess Contributions

To prevent excess contributions, implement effective tracking methods. Set up reminders to review your contribution status quarterly. Many financial institutions provide real-time updates on your progress toward annual limits, allowing for timely adjustments.

If you work for multiple employers, coordinate contribution information with each to avoid exceeding the limit. When switching jobs, calculate your contributions to date and inform your new employer of your remaining allowable contribution room. Starting with a conservative contribution percentage and increasing it later in the year can also help ensure compliance.

By staying vigilant and proactive, you can manage your 401k contributions effectively and avoid the complications associated with exceeding IRS limits.