What If I Overcontribute to a 401(k)?

A 401(k) plan is a retirement savings vehicle through employer-sponsored contributions. These plans provide tax advantages, allowing pre-tax contributions to grow tax-deferred or Roth contributions to grow tax-free. Navigating the specific rules and annual contribution limits can be intricate, occasionally leading to situations where individuals inadvertently contribute more than the Internal Revenue Service (IRS) allows. This article explains what occurs in such a scenario and the necessary steps to address an overcontribution.

Understanding 401(k) Contribution Limits

An “overcontribution” to a 401(k) occurs when the amount deposited into the account exceeds the limits set by the IRS. Understanding these thresholds is essential for compliance and effective retirement planning.

The primary limit for most employees is the elective deferral limit, which specifies the maximum amount an individual can contribute from their salary. For 2024, this limit is $23,000, increasing to $23,500 for 2025. This annual limit applies across all 401(k) plans an individual participates in, meaning if one changes jobs during the year and contributes to multiple plans, the total contributions across all plans cannot exceed this amount.

Individuals aged 50 or older by the end of the calendar year are eligible to make additional “catch-up” contributions. The catch-up contribution limit is $7,500 for both 2024 and 2025, bringing the total elective deferral limit for eligible individuals to $30,500 in 2024 and $31,000 in 2025. Starting in 2025, a new higher catch-up contribution limit of $11,250 may apply for employees aged 60, 61, 62, and 63, if their plan allows.

Beyond employee contributions, there is an overall limit on the total annual additions to a participant’s account from all sources. This includes employee elective deferrals, employer matching contributions, employer profit-sharing contributions, and any forfeitures reallocated to the employee’s account. This comprehensive limit, known as the 415(c) limit, is $69,000 for 2024 and $70,000 for 2025, or 100% of the employee’s compensation, whichever is less. Overcontributions most commonly occur due to job changes mid-year leading to contributions to multiple plans, payroll errors, or miscalculations of eligibility for catch-up contributions.

Identifying and Correcting Excess Contributions

Once an individual suspects or confirms an overcontribution, prompt action is necessary to mitigate potential tax complications. The initial step involves identifying the exact amount of the excess contribution. Individuals can typically do this by reviewing their W-2 forms, year-end statements from their 401(k) plan administrators, and their personal contribution records, especially if they worked for multiple employers during the year.

Upon identification, promptly inform the 401(k) plan administrator or recordkeeper. The plan administrator is generally responsible for facilitating the correction process, as they manage the account and its compliance with IRS regulations. Effective communication with human resources or payroll departments, particularly when multiple employers are involved, helps ensure accurate data exchange and timely processing.

The correction process typically involves a “corrective distribution” of the excess amount. This means the overcontributed funds, along with any earnings attributable to those excess contributions, must be removed from the 401(k) account. The plan administrator calculates these earnings, which represent the investment growth or losses on the excess funds since they were contributed.

There are deadlines for making these corrections to avoid more severe tax implications. To prevent double taxation of the excess amount, the corrective distribution must occur by April 15 of the year following the year the overcontribution was made. For instance, an overcontribution made in 2024 must be corrected by April 15, 2025. Obtaining an extension to file a personal income tax return does not extend this deadline for correcting the 401(k) overcontribution. The distributed funds are returned directly to the employee.

Tax Treatment of Excess Contributions and Distributions

The tax implications of an overcontribution to a 401(k) depend largely on whether the correction is made by the IRS deadline. The excess contribution itself is considered taxable income in the year it was originally contributed, regardless of whether it was initially deferred pre-tax. This amount is not treated as a distribution for tax purposes until it is actually removed from the plan.

Any earnings generated by the excess contribution are also taxable income. These earnings are taxed in the year they are distributed to the individual, not necessarily in the year the overcontribution occurred. If the excess contributions were made on a pre-tax basis, the employer may need to amend the employee’s W-2 form for the year the excess contribution was made to reflect the overcontributed amount as taxable wages.

Corrective distributions, encompassing both the excess contribution and its attributable earnings, are reported to the IRS on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” This form will include specific codes in Box 7 to indicate the nature of the distribution, such as “8” for excess contributions taxable in the year of distribution or “P” if the excess was taxable in the prior year.

If the excess contribution is not corrected by the April 15 deadline of the following year, the individual faces consequences, including “double taxation.” This means the excess amount is taxed both in the year it was contributed and again when it is eventually distributed from the plan in the future. Furthermore, if the individual is under age 59½ and the correction is not made timely, the distributed excess amount may also be subject to a 10% early withdrawal penalty, in addition to regular income taxes. However, if the corrective distribution is made by the April 15 deadline, the 10% early withdrawal penalty typically does not apply, even if the individual is under age 59½.