A 401(k) offers various tax benefits for those looking to save for retirement, but overcontributing can actually cause you more tax issues. In fact, if you don’t have the funds removed from your 401(k) in time, you could be taxed twice on that money. To make matters worse, those 59.5 or younger would then also be subject to a 10% tax penalty on those funds. That makes adhering to the IRS’ annual contribution limits incredibly important.
Do you have questions about planning out your retirement? Speak with a financial advisor today.
What Is the Maximum Contribution?
What is the maximum contribution for a 401(k) plan? According to the IRS, the 401(k) contribution limit for employees participating in 401(k) plans is $22,500 for the year 2023.
However, if you’re 50 or older, you can contribute a certain amount more than the limit as a “catch-up” contribution. In 2023, the catch-up contribution amount is $7,500, bringing the total you can contribute to your 401(k) to $30,000 if you’re 50 or older.
These amounts are often updated on an annual basis. In 2022, the maximum contribution was $20,500 and the catch-up contribution was $6,500. Make sure you’re referencing the correct annual numbers for your calculations.
These numbers do not include employer contributions. If your employer offers a contribution, they have different limits. In 2023, the total amount you can contribute including employer contributions is $66,000. The only problem you could have is if you personally go over the individual contribution amount.
What to Do if You’ve Overcontributed
If you now realize you’ve overcontributed, don’t panic—this can usually be fixed with minimal fuss as long as you act quickly. Here are some steps to take:
1. Contact Your Employer or Plan Administrator Immediately
Let your employer know that you’ve overcontributed. Time is of the essence—catching the error before tax day is extremely helpful. Tax day for your 2023 401(k) contributions is April 15, 2024.
2. Correct Your Tax Forms
If you can catch the problem before tax day and before you file your taxes, you can get a corrected W-2 to use. If you didn’t catch it early enough, you’ll still follow these steps, but you’ll need to file an amended tax return.
3. Pay Taxes on the Excess Contribution
Your employer will return the excess money to you as well as any funds that money earned. You’ll owe taxes on that amount and perhaps an early withdrawal penalty.
Let your employer or plan administrator know, and they’ll correct the situation by returning your money and fixing your tax forms. Then you’ll need to correct your tax paperwork and payments on your end.
What Penalties Will You Have to Pay?
Beyond the stress and annoyance, the penalties for overcontributing can include problems with your tax return, additional taxes and penalties.
If you can fix the error before the tax day deadline, the fallout is relatively minor. You’ll need to file your taxes using the updated W-2 and you’ll have to pay taxes on the overcontribution as if it were wages.
Think of it this way: If you hadn’t overcontributed, that money would have come to you via your usual paycheck, so even though it’s coming late, it’s taxed as if it were.
However, if you miss the deadline, you’ll owe those additional taxes and you may have to pay a 10% early withdrawal penalty on the amount. Then you’ll owe additional taxes again—yes, once for the tax year in which you made the mistake and again in the year in which it was corrected.
How Overcontributions Can Happen
Usually, overcontributions occur because you have two sources of retirement savings and aren’t keeping track. If you have the same employer and retirement account for a full tax year, it’s more likely that your employer or plan administrator may catch the error.
If you change jobs and have two 401(k)s, however briefly, problems can pop up. This can also happen when you work multiple jobs and have 401(k) plans associated with each, so make sure you’re keeping track of all 401(k) plans you may have.
Another common stumbling block is when you get a significant raise or bonus and forget that your 401(k) is set to take out a set percentage of your paycheck. If you’re calculating from your previous, normal salary you might be well within your limits, but with a bigger paycheck comes a bigger 401(k) deferral.
Whenever taxes come into play, finances can get complicated. And retirement savings are no exception. If you think you have overcontributed your 401(k) plan, don’t hesitate to reach out to your employer or plan administrator. And when you are in the middle of tax season, you want to get that situation fixed right away before tax day. Or you could be dealing with penalties.
Tips for Managing Your Retirement Savings
- Saving for retirement is much easier said than done, but a financial advisor can help with that. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- A 401(k) isn’t the only place you can save for retirement. An individual retirement account, or IRA, is another option. It has a contribution limit of $6,500 for 2023 and offers the same tax benefits as a 401(k). Roth IRAs, on the other hand, don’t provide an upfront tax deduction, but you won’t have to pay taxes on your income when you retire.
- If you are taking advantage of employer 401(k) matching, SmartAsset’s 401(k) calculator can help you figure out how much you will have based on your annual contribution and your employer’s matches.
Photo credit: ©iStock.com/AndreyPopov, ©iStock.com/jygallery, ©iStock.com/Cn0ra