The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Massachusetts is representative of common inquiry about a 401(k) plan participant’s annual Internal Revenue Code (IRC) Section 402(g) limit on salary deferrals. The advisor asked:
Highlights of Discussion
- Since the Section 402(g) annual limit on employee salary deferrals is an individual participant limit, if an employee exceeds the limit ($17,500 for 2014 for those under age 50 and $23,000 for those age 50 and above) — regardless of the number of plans in which he or she participates during the year — an excess deferral is created.
- If a participant has excess deferrals based on the elective contributions made to a single 401(k) plan or plans maintained by the same employer, then the plan must return the excess deferrals and their earnings to the participant no later than April 15th of the year following the year the excess was created (Code Section 401(a)(30) and Treas. Reg. §1.402(g)-1(e)(1)).
- The IRS could disqualify a plan for violating the elective deferral limitation, resulting in adverse tax consequences to the employer and employees under the plan. But there are ways to correct the error.
- In the case where an employee participates in more than one salary deferral-type plan of unrelated employers, then the participant must notify the plan administrator of the amount of excess deferrals allocated to it prior to the April 15 correction deadline (usually a notification date is specified in the plan document). The plan is then required to distribute the excess and earnings to the participant no later than the April 15th correction deadline (Treas. Reg. §1.402(g)-1(e)(2)).
If the excess deferrals are withdrawn after the April 15 correction deadline, then:
- The consequences when the excess deferrals are timely withdrawn by the April 15 correction deadline are:
— The excess deferrals are taxed in the calendar year deferred.
— The associated earnings are taxed in the year distributed.
— There is no 10% early distribution penalty tax and no 20% withholding (since the amounts are ineligible for rollover).
- If the excess deferrals are withdrawn after the April 15 correction deadline, then:
— Each affected plan of the employer is subject to disqualification and would need to go through the IRS’s Employee Plans Compliance Resolution System to properly correct the error.
— The excess deferrals are subject to double taxation—taxed in the year contributed and in the year distributed.
— The associated earnings are taxed in the year distributed.
— The excess deferrals could also be subject to the 10% early distribution penalty tax.
