Correcting 401(k) contribution errors involves identifying the mistake, adjusting future contributions and potentially making retroactive corrections to comply with IRS limits and plan rules. If you discover that you have over-contributed, the first step is to notify your plan administrator.
If you need help with your retirement plan, a financial advisor can work with you to analyze and manage investments.
Common 401(k) Contribution Errors
Maintaining accurate records and promptly addressing any discrepancies can ultimately help you maximize benefits and ensure financial security. Here are five common 401(k) contribution errors to look out for.
Contributing Too Much
The IRS sets annual contribution limits and exceeding these limits can result in penalties. For 2024, the limit is $23,000 for individuals under 50, with an additional catch-up contribution of $7,500 permitted for those 50 and older. If you contribute more than these amounts, you will need to withdraw the excess amount by April 15th of the following year to avoid a 6% excise tax.
Under-Contributing and Missing Employer Matches
Not taking full advantage of the maximum contribution limit means missing out on potential tax benefits and compounded growth over time. Additionally, failing to contribute enough to receive your employer’s full match is essentially leaving free money on the table.
Taking Early Withdrawals and Loans
Early withdrawals before age 59½ typically incur a 10% penalty. This means that you will have to pay this on top of regular income taxes for the amount withdrawn.
Additionally, taking a loan from your 401(k) could also eat into your retirement savings. Those funds must be repaid with interest in a specified period. Failure to repay can result in the loan amount being treated as a taxable distribution, and most plans won’t let you contribute while you have an outstanding loan.
Missing Required Minimum Distributions (RMDs)
Once you reach the age 73, the IRS requires you to take minimum distributions from your 401(k). Failing to withdraw the required amount can result in a 25% tax penalty on the amount that should have been withdrawn.
Neglecting to Update Beneficiaries
Neglecting to update your 401(k) beneficiaries can cause complications in the event of your death. Life changes such as marriage, divorce or the birth of a child require that you review and update your beneficiary designations so that your assets get distributed according to your wishes. Regularly checking and updating this information can also prevent potential legal disputes and ensure your loved ones are taken care of.
What to Do If You Contribute Too Much to Your 401(k)
Contributing too much to your 401(k) can happen if you’re not mindful of the annual contribution limits set by the IRS. For 2024, the limit is $23,000 for individuals under 50, with an additional $7,500 catch-up contribution for those aged 50 and above.
It is essential to monitor your contributions throughout the year to avoid exceeding these limits. If you discover you’ve overcontributed, there are specific steps you need to take to correct the issue and avoid penalties.
The first step is to notify your plan administrator as soon as you realize the mistake. The plan administrator can help you withdraw the excess contribution amount. This must be done by the tax return due date for that tax year (usually April 15 of the following year) to avoid an excise tax on the excess amount (more information in the following section).
When you withdraw the excess contribution, it will be subject to regular income tax. However, the sooner you correct the error, the less complicated your tax situation will be. The IRS requires that any earnings on the excess contributions be included in your taxable income for the year you withdraw them. Additionally, any earnings on the excess contribution will be taxed in the year they are withdrawn.
Penalties for Over-Contributing to Your 401(k)
If you over-contribute to your 401(k), the excess amount is subject to a 6% excise tax each year it remains in the account. This penalty is imposed on top of your regular income taxes.
To avoid this recurring penalty, you must withdraw the excess contribution by April 15th of the following year. Failure to do so means the excise tax will continue to apply each year the excess amount remains in your account.
As such, to mitigate penalties, you must act quickly once you realize you’ve over-contributed. Contact your plan administrator to facilitate the withdrawal of the excess amount. This includes removing any earnings generated from the excess contribution, which are also subject to taxes.
To prevent over-contributing in the future, regularly review your 401(k) contributions. Many employers provide tools to track your contributions, helping you stay within the annual limits. Setting up automatic adjustments can also help prevent unintentional over-contributions. Additionally, consulting with a financial advisor can offer personalized strategies to manage your contributions effectively and avoid penalties.
Bottom Line
Regularly reviewing your contributions and understanding IRS limits can help prevent mistakes in the future. Working closely with your plan administrator errors and consulting a financial advisor can provide the guidance needed to navigate any corrections smoothly. By staying informed and being proactive when correcting 401(k) contribution errors, you can ensure your 401(k) remains a powerful tool in securing your financial future.
Tips for Retirement Planning
- A financial advisor can help you analyze and manage investments for your retirement. 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.
- If you want to figure out how much you will need to save for a comfortable retirement, SmartAsset’s retirement calculator can help you get an estimate.
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