401k Over-contributions
February 7, 2007 2:55 PM   Subscribe

How do I remedy over-contributions to 401k plans? Of course there is more....

Since my second employer during 2006 neglected to appropriate handle my reporting to them of amounts of prior 401k contributions during 2006, they ended up withholding amounts from my pay (per my percentage-based instructions to them) amounts in excess of the 2006 aggregate limit of $15,000.

The 401K plan administrator and my employer tell me that I should request a distribution from the plan of amounts contributed in excess of the aggregate limit and all related gains/losses. I have done this, and they tell me that it is being processed, and that I should expect the distribution (the excess contribution and related gains/losses) in a few days.

However, they tell me that I won't get a 1099R until 2008 for this distribution during tax year 2007, even though, since I am taking the distribution before April 17, 2007, I can get the excess contribution out of the plan without having double taxation issues.

Since I will get the 1099-R and use it for my taxes next year, I presume that I will pay tax then on the gains. Or, for the tax year 2007, will I also pay taxes then on the distributed portion in addition to the gains or losses?

Anyway, my question is, what do I do now? I presume that I can't just file everything without accounting for this, since it will show that I contributed too much to my 401ks during 2006. And because I didn't pay tax on the excess contributions, which I should have.

So, I guess my question is, how do I reflect this on my 2006 return? I guess that I can just manually reduce my 401k contributions to reflect what they really are post-distribution, or I can manually add put the distributed amount to 1040 Line 7? How do I do these things using TurboTax Online? Or do I do nothing and deal with it next year?

I am done with everything else and definitely do not plan to use a tax preparer just because of this question. I have called the IRS but have gotten some confused and different answers.
posted by jcwagner to Work & Money (6 answers total)
As with all moderately confusing tax questions, contact an accountant. I'm guessing that you'll need somebody to make sure you don't pay double taxes or penalties on the amount somebody else screwed up about.
posted by cschneid at 3:06 PM on February 7, 2007

Since you're allowed to contribute to a retirement plan up until April for the previous tax year, the IRS is used to getting returns that look like this:

amount contributed according to documentation: $small
amount contributed, according to the return: $large

That's what they see when there's a last minute contribution, right? So what's the problem with a last-minute non-contribution?

amount contributed according to documentation: $large
amount contributed, according to the return: $small

No problem. The IRS is used to those numbers not matching.

In 2007, you won't pay tax on the body of the distribution, because you're paying tax on it in 2006 (think about it...). You may not have had tax *withheld* on the income that went into the 401K wrongly; but you will pay tax on it this year. Presumably you'd pay tax on the gains next year.
posted by jellicle at 3:19 PM on February 7, 2007

That makes sense and jives with what I have been hearing. But how and where (what form should I complete or what manual adjustments should I make?) do I report that fact that I didn't really contribute $15k + X into 401k plans in 2006, since I received a distribution of X and all related gains?

All the information I find (and the IRS) seems to suggest that this is all in Publication 525, but it doesn't answer how to report it.
posted by jcwagner at 3:39 PM on February 7, 2007

Publication 525, page 9: "You must include the excess deferral in your income for the year of the of the deferral... File form 1040 to add the excess deferral amount to your wages on line 7."

So you're literally going to write, on the dotted line adjacent to line 7 on your 1040 (no A or EZ for you this year!):

"excess 401k deferral: $1,234"

and then in the main numeric box for line 7, you're going to write a number that is the sum of all your W-2 forms (your regular wages as reported) and the amount that you just wrote in on the dotted line (which is an amount that should have been reported as wages, because it shouldn't have been sent to your 401k plan).
posted by jellicle at 7:07 PM on February 7, 2007

Why not just let it ride? The excess goes in after tax, but it still gets saved. If you take the cash now you'll likely just blow it on beer. If you let it ride you can blow it on beer when you are 59 1/2.
posted by caddis at 7:30 AM on February 8, 2007

Jellicle: Great advice - thanks! Now I just have to figure out how to do that in TurboTax. Ugh.

caddis: I don't want to let it ride because I don't want to mix tax-deferred and non-tax-deferred investments in the same account. Also, I think that I need to make sure that I pay tax on that income this year, since I will be subject to double taxation if I don't receive a distribution of it by 4/17/07. Don't worry, it's ultimately being saved for my retirement beers, etc.
posted by jcwagner at 9:38 AM on February 8, 2007

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