Excess Contribution to 401(k) for 2020
I received an e-mail on April 6 from the administrator of my employer’s 401(k) plan informing me that I would be receiving a refund that represents “the annual contributions plus associated earnings that exceeded the IRS limits ($57K) for 2020”. The e-mail also stated “You will not be taxed on the portion of your refund representing excess contributions, but the associated earnings included in your refund are considered taxable income for 2021. In accordance with tax laws, [my employer] will withhold 10 percent from these earnings. A Form 1099-R will be mailed to you next January for tax reporting purposes.”
Since I had the after-tax contributions and associated earnings distributed last year, which is done each year, to my Roth IRA, I was not sure of which sub-account the excess funds would be distributed from. Based on the April 9 transaction, a total of $636.04 ($631.29 2020 excess contribution confirmed by the administrator and $4.75 in earnings) was withdrawn from the “Profit Sharing” sub-account. Apparently, the annual “Profit Sharing” contribution by my employer in February 2021 for the company’s 2020 performance was the “last in” contribution contributing to the excess contribution associated with 2020. This approach differed from my originally impression of monitoring both employee and employer contributions deposited within the calendar year to minimize excess contributions.
Yesterday, April 15, I received the refund check for $572.44, reduced by $63.60 for Federal taxes (apparently 10% early withdrawal tax). Based on the information I read on the IRS website (Retirement Topics – Exceptions to Tax on Early Distributions), “corrective distributions (and associated earnings) of excess contributions made timely” are an exception for the 10% early withdrawal tax. However, the April 6 e-mail implied I would only be taxed on the “associated earnings”, which would be $0.48 based on the $4.75 of earnings and not the total $636.04 refund. At this point, I’m not sure which is the correct application.
I’m also curious as to what to expect in January regarding the 1099-R. I suspect Boxes 1 and 2a would reflect $636.04, Box 2b: Taxable Amount not determined, Box 4: $63.60 and Box 7 – Code 8 based on the information from the refund statement I received. Again, I’m not sure this would be correct based on the inconsistent information in the prior paragraph.
Any insight as to the correct approach/expectation would be greatly appreciated. Thanks!
Permalink Submitted by Alan - IRA critic on Fri, 2021-04-16 22:54
No, the 1099R next January will have to calculate the exact taxable amount in Box 2a, and it will be the entire amount. The 63.60 is the 10% default withholding (not rollover eligible) on the taxable portion, so that confirms that the gross distribution is taxable. Again, this is ordinary taxes not an early withdrawal penalty, which does not apply to this distribution. The 636. will be taxable in the year received (2021), not 2020.
My guess is that the plan intially intended to refund your after tax contributions, sent the email, then discovered you had rolled out the after tax amounts which then required the plan to tap a pre tax source to return to you. The taxable amount then became the total amount, but they then should have correted the first e mail. It does seem odd that after you rolled the after tax to your Roth IRA last year, that you did not make enough after tax contributions after that which could have been used for the distribution of excess.
Permalink Submitted by Bradley Bjerning on Sat, 2021-04-17 12:58
Thank you for the feedback. Your suspicion that the template e-mail was written with the expectation that funds from the after-tax subaccount were available makes sense. I knew all along that the gross distribution would be taxable since the basis was employer contributions and associated earnings but I appreciate the clarification that the taxes withheld are ordinary taxes and not an early withdrawl penalty. Regarding your concern regarding the availability of after tax contributions to fund the excess distribution, each year, I fund after tax contributions in Q2 and Q3 each year (pre tax and catch up are funded in Q1 and Q4) and then request the distribution of after tax contributions and associated earnings in early October. The reason for this approach is because the plan documents allow, if under age 59 1/2, only one withdrawl per year from the after tax subaccount and requires a 6-month suspension of after tax contributions. Therefore, no after tax funds are available in the remainder of Q4. Next year in mid-March, I’ll be 59 1/2 and will no longer have this limitation.