The most important thing to do besides avoiding overcontributions on IRA and 401(k) accounts is fixing them. If not, you could face some hefty financial consequences. Take a look at the consequences if you don't fix overcontributions on IRA and 401(k) accounts.
The deadline to report and fix overcontributions on retirement saving plans is April 15th. If you check the contributions you’ve made during the previous year in January or February, you’ll be more likely to catch any problems on time to report them and start the excess’ withdrawal by the beginning of March, ideally. If not, prepare to face the consequences.
It should be pointed out that employer contributions aren’t added to yours when calculating if you went over your contribution limit. If they have a matching program, the amount they contribute isn’t counted against your account contribution limit.
In the case of a 401(k) account, you’ll have to pay twice as many taxes on your excess contribution. In essence, you’ll end up paying taxes on it according to the year it was contributed, and the year it was withdrawn from the account. If you fix the overcontribution, you’ll only pay the second taxes.
This action of taxing the excess twice, first when it’s contributed and next when it’s distributed, is called double-taxation. You can be required to pay a lot, especially if you’ve overcontributed a high sum of money to your retirement account.
The case of IRA accounts isn’t too different. If you miss the April 15th deadline, there are two things you can do. Firstly, it’s possible to take out the excess within 6 months, until October 15th, and file an amended return by this date. Make sure to remove the difference first from your Roth IRA and then your traditional IRA account, if you’ve gone over your combined contribution limit.
The second option is to reduce your contributions for the next year by the amount of the excess you’ve overcontributed. This means that your new contribution limit will be the old limit minus the amount you’ve overcontributed. This will include a 6% penalty tax until you’ve absorbed or corrected the excess.