401k excess contribution penalty

Submitted by Ed Snyder on Mon, 2019-08-12 14:34

Have a business owner with solo(k). Hired an employee in Oct 2018. He continued making solo(k) contributions for 2018 and 2019. The 2019 contributions will not be allowed. Is there any way to avoid the excess contribution penalty?



Submitted by William Tuttle on Tue, 2019-08-13 04:19

  • A small business owner can adopt and maintain a one-participant 401k as long as they have no non-spouse eligible employees.
  • Except for Vanguard, most one-participant 401k plan providers allow the plan sponsor to elect employee eligibility restrictions. These restrctions are up to >= age 21 and up to one (1) year of service with up to >= $1,000 hours per year. This allows the plan sponsor to exclude those < age 21, part-time employees working < 1,000 hours/year.  For those working > 1,000 hours/year, the plan sponsor has one (1) year to terminate the plan or amend to a 
  • If this is not Vanguard, you should review the one-participant 401k adoption agreement to determine if the business owner elected the above employee eligiblility restrictions. If the business owner elected the maximum employee eligibility restrictions. There are no plan errors at this time. They will have until the one (1) year anniversery to terminate or amend the the one-participant 401k plan to a plan covering non-spouse employees. 
  • If it is a Vanguard plan or no employee eligibility restrictions. The plan was in error on the date of hire. Contributions made before that date are legitimate.
  • Excess employer contributions can be returned with earnings until the tax filing deadline. The contribution is not deductible and if the 2018 return has already been filed, it must be amended to remove the deduction. The earnings are taxable in the year of distribution. There will be no penalties unless you don’t get this done by the tax filing deadline including extensions.
  • Excess employee deferrals can only be returned if done by 4/15. At this point the excess deferral is not deductible, no basis is tracked and it will be taxed upon withdrawal. This results in double taxation. The ability to distribute the excess deferral depends on whether the plan is terminated or amended.
  • Terminated: You can distribute the excess the same as any other assets, but they will be subject to ordiary income taxes and if applicable the 10% early withdrawal penalty. In most cases it is best to just rollover the assets.
  • If you amend the plan, you can only distribute the excess when a distributable event occurs. E.g. Plan termination, separation, age 59 1/2, etc… 
  • The treatment of excess employer contributions and excess employee deferrals is outlined in IRA Publication 560, Chapter 4 Chapter 4. Qualified Plans.

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