There’s common knowledge of the IRS limit for 401(k) and IRA contributions, but the consequences if you go over it are not as well-known. What to do in case of a 401(k) or IRA overcontribution? Learn what could get you in this situation and how to solve your problems!
Before starting, don’t panic and frantically check your accounts. This isn’t such a common situation. First of all, you need to have enough money available to overcontribute to a 401(k). On top of this, chances are your plan administrator will keep you from exceeding your annual limit.
However, there are certain situations when overcontributing to a 401(k) account can be a more likely outcome. For example, if you switched jobs throughout the year you can end up going over your contribution limits. Another situation would be if you worked two or more jobs and had a 401(k) with each one.
The key to avoid surpassing the limit of your total 401(k) plan contributions is to work closely with plan administrators. If they know the big picture, they’ll help you avoid such complications. They’re also the ones to go to if you notice an overcontribution and wish to fix it. This is an advice from the IRS, who also indicates it should be done before April 15th of the next year.
Once you’ve done this, it’s important to notify the plan. You should ask them to pay the difference or “excess deferral” out of the plans that allow these distributions. The plan will then have until April 15th of the next year to pay you that amount, which will be considered part of your gross income for the year in which this excess was contributed.
Keep in mind that the interest that you’ve earned on this excess will be taxed based on the year it was taken out of the account. This is why you should fix your overcontributions ASAP; the more time you let go by, the higher the difference will be, and the more expensive your taxes on this amount will end up being.
In the case of an IRA account, there’s the same deadline to fix your overcontributions. You just need to withdraw the excess contributions as well as their earnings. If you went over your combined contribution limit with a traditional IRA and a Roth IRA and you contributed to both of them in the same year, you’ll first have to take out the excess from the Roth IRA.