What are the 402(g)/415(c) limits?
The IRS sets limits on how much an employee (a plan participant) can contribute to a retirement plan each year, both through personal contributions (402(g) limit) and combined employee and employer contributions (415(c) limit). Sometimes plan sponsors run into situations where an employee exceeds one of these limits. Fortunately, there are ways of fixing these errors.
What happens if my employee (plan participant) exceeds the 402(g) limit for the plan year?
Time to correct the errors is important. If the employee exceeds the deferral limit for the plan year, you must distribute the excess deferrals by April 15 of the following year. Excess deferrals for the previous year that are withdrawn by April 15 of the following year are included in the employee’s gross income for the plan year. Bear in mind that the earnings on the excess deferrals are taxed in the year they are distributed. The distribution is not subject to the additional 10% tax on early distributions.
What happens if the excess 402(g) deferral is not withdrawn by April 15?
Any excess deferral left in the plan is taxed twice, once when contributed and again when distributed.
Excess contributions are taxed at 6% per year for each year the excess amounts remain in the plan.
What should I do if we exceed the 415(c) limit?
First, distribute the excess to the affected employee, which the employee will have to include as income. However, the employee will not have to pay the additional 10% tax on the early distribution.
You should then transfer the forfeited employer contributions (profit-sharing or matching) to an unallocated account. These amounts are then used to reduce the employer’s contributions in the current year and, if applicable, subsequent year(s).
How do I report these excess deferrals limits to the affected employee (both 402(g) and 415(c))?
The permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable in the year of deferral and in the year distributed. These amounts are reported on the Form 1099-R.
For Roth contributions, the excess deferral will already have been reported as income in the year of deferral. However, the excess amount will be reported as taxable in the year distributed.
Notify Vestwell (if we serve as your plan administrator) before April 15 of the following year that you would like the excess deferral amount, adjusted for earnings, to be distributed to the employee from the plan. Note, the April 15 date is not tied to the due date for the employee’s tax return.
As a plan sponsor, what should I do to avoid exceeding these limits?
Plan sponsors should pay careful attention to the plan limits for both 402(g) and 415(c), because they do change annually.
Work with your plan administrator to ensure that the administrator has sufficient payroll information to verify that the deferral limitations of 402(g) and 415(c) were satisfied.
Establish procedures to ensure that, based on the employee election forms (including modifications), employees won't exceed the 402(g) and 415(c) limits.
Have checks and balances in place to alert you and your plan administrator when the limit is exceeded to take timely corrective action.
The above is intended for informational purposes only. Vestwell is not a law firm or tax advisor and understands each plan situation is different. Plan sponsors should consult with their tax advisors to see what option is best for their specific situation.