401(k) Overcontribution

I have a client who over-contributed to his 401(k) during 2019. This was all one employer, not multiple, and the over-contribution went in post-tax along with his $19k pre-tax contribution. It seems like the excess was NOT treated as an excess deferral.

My understanding is that if it was an excess deferral, client would have had to remove it by 4/15, and pick it up in income, or pay the excise tax.

Google is telling me that my client has no such problem based on the fact pattern. That this excess, post-tax contribution to his 401(k) gives him basis in the 401(k) (much like a Roth 401(k) would), and that he can specify that portion gets rolled over into a Roth IRA, while the other, pre-tax contributions and earnings go to a Traditional IRA, when he leaves his company.

Is this correct? This is my first time dealing with this situation. Does the client have any filing obligations, like he would if this would have been a post-tax contribution to a Traditional IRA (8606)?

More than $19K code D in box 12? Combined employee-employer is $57K.
More if 50 or older.
Also, of interest:
https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/w2-errors-401k-deferrals.aspx#:~:text=Employers%20must%20report%20401(k,correct%20their%20Forms%20W%2D2.&text=Elective%20deferrals%20made%20to%20403,Other%20non%2Dqualified%20amounts.

Client is well below age 50. Doesn't get the catch-up.

The client told me about the excess contribution, and showed me a year-end payroll statement that has $19,000 for pre-tax 401(k) contribution, and another, smaller amount for "post-tax 401(k) contribution". His W-2 has exactly $19k for code D, box 12. No other box 12 codes except code C (term life more than $50k).

I think it's an excess contribution, the employer should fix it. I'd be curious to know what you found that would allow an excess contribution to stand.

It is not an excess. There are 4 types of 401(k) contributions:

(a) Pre-tax 401(k) contribution
(b) Roth 401(k) contribution
(c) Employer 401(k) contribition
(d) After-rax 401(k) contribition

The following are the limits for each type:

(a) + (b) <= 19,500
(a) + (b) + (c) + (d) <= 57,000

If the employer plan provides In Plan Roth Conversion, the employer can convert the principal of After-rax 401(k) contribution to ROTH IRA, and the earnings from After-rax 401(k) contribition to traditional IRA.

Few employers, mostly in Silicon Valley, offer After-rax 401(k) contribition and In Plan Roth Conversion. You do not need to do anything extra as far as tax return is concerned.

Reference: https://www.irs.gov/retirement-plans/pl ... tributions

Types of employee contributions

...
After-tax contributions are contributions from compensation (other than Roth contributions) that an employee must include in income on his or her tax return. If a plan allows after-tax contributions, they are not excluded from income and an employee cannot deduct them on his or her tax return.
...

Sorry it has taken me so long to get back to this...I got side tracked with other clients.

I'd be curious to know what you found that would allow an excess contribution to stand.

Howard, just non-authoritative sources like this: https://www.kiplinger.com/article/retir ... th%20401(k).

Thanks to puravidatpt for posting the IRS website. My understanding of the situation mirrors his/her post.

So is my understanding that we don't have to file anything with the client's income tax return correct? We merely track the after-tax contributions in client's 401(k) as they create basis. When client leaves this company he should roll the after-tax contributions into a Roth IRA and the related earnings, along with pre-tax contributions and their earnings into a Traditional IRA?

And to be specific, it's not allowing an "excess contribution" to stand. I think we're dealing with two different things...an excess deferral on one hand, which does not apply to my client, and after-tax contributions on the other hand, which is what's going on here.

Excess deferrals are probably most common when a client switches jobs during the year, and either the client and/or the new company's HR drops the ball on limiting 401(k) deferrals at the new job.

I think there is a solution. Client needs to find out (Summary Plan Description) if this plan allows non-deductible contributions.

If so, you're good to go. If not, you have an excess contribution that needs to come out by the due date of his tax return. Earnings need to come out also. It's an excess contribution, but never deducted. Only the earnings will be taxable. Since the excess deferral will be returned to the taxpayer post 7/15, taxation of earnings happens in 2020.

And to be specific, it's not allowing an "excess contribution" to stand. I think we're dealing with two different things...an excess deferral on one hand, which does not apply to my client, and after-tax contributions on the other hand, which is what's going on here.

Excess deferrals are probably most common when a client switches jobs during the year, and either the client and/or the new company's HR drops the ball on limiting 401(k) deferrals at the new job.

I also see a lot of excess deferrals with "Top hat" 401k's, or 401k's that are not safe harbor 401k's.

Thanks Doug, I'll request the plan docs.

We merely track the after-tax contributions in client's 401(k) as they create basis. When client leaves this company he should roll the after-tax contributions into a Roth IRA and the related earnings, along with pre-tax contributions and their earnings into a Traditional IRA?

If the plan allow in-service withdrawal to a Roth IRA or in-plan rollovers to a Roth 401(k), then the employee can do the transfer without leaving the job.

I believe facebook provides this type of plan, the after tax contribution is likely in a different bucket separate from pre-tax 401(k).

If the plan allow in-service withdrawal to a Roth IRA or in-plan rollovers to a Roth 401(k), then the employee can do the transfer without leaving the job.

Yup.

I figured I'd add to an existing thread rather than start another. I wanted to confirm my understanding of how to handle an excess deferral in 2020.

Client had two employers in 2020. Client contributed $5,000 to Employer A’s 401k plan in February 2020 and left to work for Employer B. He contributed $19,500 to Employer B’s plan as of July 2020. In both cases, client made pre-tax contributions, not Roth 401k contributions.

In August 2020 client notified the custodian of Employer B’s plan of the excess deferral. The custodian sent the client a check for $4,800 made up of:
$5,000 excess deferral
$100 of earnings (interest)
($100) state withholding
($200) fed withholding

I want to make sure I understand how the client’s 2020 paystub, 2020 W-2, and 2020 1099R will present this information.

Client’s paystub as of October 1 shows the $19,500 as the YTD contributed amount. Taxable wages per the paystub have only increased by the normal pay period amount, not the $5,000. At first glance, I expected the employer would add the $5,000 to wages on the paystub and reduce the YTD 401k amount to $14,500 ($19,500 less $5,000 excess). But now I think perhaps the employer will leave everything as is for 2020.

Here are my assumptions:

1. Employer B will leave client’s paystub as is and show client’s 2020 W-2 as follows: Report box 1 wages that include the $19,500 deferral and show $19,500 in Box 12.

2. The client will receive a 2020 1099R from custodian reporting $5,100 in Boxes 1 and 2 and Code 8 in Box 7. I assume there will only be one 1099R since Code 8 reports both excess deferrals and earnings thereon.

3. On the 2020 tax return, I will enter the W-2 exactly as issued: with taxable wages net of the $19,500 401k deferral and box 12 showing $19,500. I will then enter an excess deferral amount that will add 5,100 to the wages line of the 1040. Nothing will be reported on the pensions line of the 1040.

At first, I thought I would need to break out the $5,000 on the wages line and $100 on the pensions line, but it looks like my software will put the entire $5,100 on the wages line. This makes sense considering both the $5,000 and the $100 would be taxed as ordinary income and I don’t need to worry about FICA. The $5,000 has already been subject to FICA and is included in Box 3 and 5 and the $100 is only being added to taxable wages, not FICA.

Bottom line, ultimately, I'm adding $5,100 to the wages line of the 1040.

Any comments are much appreciated.

Fix the overcontribution now and 2020 1099's are not an issue.

You left out age related, I will assume under age 50. Contribution amount for 2020 is $19,500. You are $5,000 over. Get the $5,000 plus earnings out. It is that simple. I don't where the $100 comes from (5,100 v 5,000).

Current employer should have capacity to issue correct W-2 after the $5k is restored. Correct it on q4.

The over contribution has been corrected. The client received the $5,100 from the custodian ($5,000 excess + 1$00 in earnings) in 2020. I assume a 2020 1099R will be generated from the custodian, since it handled the refund. Is that not correct?

Sorry, missed the $100 earnings. You will get a 1099-R from the custodian for $5,100 with $100 taxable.

Thanks. And to answer your first question, client is under 50. Just to clarify, I have no control over the payroll for the employer. As far as the code for the 1099R, would it be Coded as 8? I'm just trying to anticipate what will happen in January so I don't have to ask in April.