IRS Reviews Consequences to Participants of Excess 401(k) Deferrals

Recently, the IRS issued an Issue Snapshot addressing participant consequences when excess 401(k) deferrals are made. Elective deferrals include both pre-tax salary reduction contributions and any designated after-tax Roth contributions. 

As a refresher, IRC Section 402(g) limits the amount of elective deferrals a participant may exclude from taxable income each year. Excess deferrals can cause a tax liability unless corrected. A participant can generally correct an excess deferral by distributing the excess amount, plus any amounts earned on that excess (for the calendar year during which the deferral is made), no later than April 15 following the close of the calendar year in which the deferral is made. If the correction is not made by April 15, the excess can only be distributed during a time prescribed in the plan document. If not timely distributed, the excess amount is included in the participant’s taxable income for the year in which it was contributed and would be taxed a second time when the deferral is eventually distributed from the plan. 

It is important to note that catch-up contributions can affect the limits under Section 402(g). Catch-up contributions must be permitted by the plan and the participant must otherwise be eligible to make these catch-up contributions (e.g., at least 50 years old by the end of the calendar year in which the contribution is made and elective deferrals have been made up to the applicable limit). If the requirements for catch-up contributions are met, amounts that exceed the deferral limit will not be treated as excess deferrals and, thus, no corrective action may be needed. 

Employers sponsoring 401(k) plans should work closely with their plan administrators or vendors to ensure it has procedures in place to identify potential excess deferrals and implement corrective actions as needed.

IRS, Issue snapshot — Consequences to a participant who makes excess deferrals to a 401(k) plan