401k question

[Matt Sova]

Client just called me with this question and, I don't feel like researching it and I hope someone has had a similar situation.

He worked at Job 1 most of the year and contributed $13,000 to the 401k. He leaves Job 1 and starts Job 2. So far he has contributed $4,000 to that 401k. Total contributed is $17,000. He is under 50 so he has contributed $2,000 too much. What should he do?

I put into my 2005 tax program the same situation and it just gave me an FYI diagnostic that he is overcontributed. Should he pull out the additional $2000 plus earnings like an IRA contribution?

Matt

[Snaggletooth]

Other Income

There is no recourse in dealing with the employers and their W-2s -- each calculated independently of the other, and I don't know how you would EVER get either employer to alter the W-2s. I'm assuming code "D" in Box 13 is adding up to $2,000 more than the maximum deferral.

Rather than going to the employers: There is always the ability to claim $2000 on line 21, and then that fixes the whole problem.

The whole problem for this year, that is. There's a bigger problem down the road. He now has a $2000 basis in his 401k plan(s). Obviously if either plan distributes to him, they are going to designate the entire amount as taxable and he will never receive the benefit of the $2000 non-taxable amount.

So I see two alternatives:

1) Work with the 401k custodian to assure that the post-tax investment is recorded properly. This is going to be almost as much trouble as working with the employers. If this is going to require your time as a CPA to fix this mess, he will quickly spend as much
paying you as any tax benefit he will receive.

2) Beginning with the year in question, start filing form 8606 to establish basis and continue to file this every year. I know the form is designed for IRAs, but I am currently filing it every year for a lady's $4300 basis in a state-run 403(b) program. She paid for this with after-tax money, and no one else is recognizing it. If she ever takes distribution, I guess it will hit the fan at that time and we'll see whether I can make the basis stick.

Excellent question

[veritas]

I would have the client ask the plan administrator to return the excess contribution plus earnings.

[abby]

10%

I agree that the excess deferrals need to be returned - not by the employer, but by the plan.
TB 13-5 says that the 10% excess contributions penalty doesn't apply if distribution is within 21/2 months of the plan year

[BOB W]

Yes..

... he must withdraw the funds ASAP. Hopefully by 12/31/06, before the issue ends up on his W-2. So he will have to get in touch with the plan administrator AND the employer ( to fix the W-2 before it is even issued).

If it ends up on the W-2, March 15 is the final "fix" date.

[Jan]

More information on excess contribution.

Treatment of excess deferrals. If the total of your elective deferrals is more than the limit, you can have the difference (called an excess deferral) returned to you from any of the plans that permit these distributions. You must notify the plan by April 15 of the following year of the amount to be paid from the plan. The plan must then pay you that amount plus allocable earnings by April 15 of the year following the year in which the excess occurred.

Excess withdrawn by April 15. If you withdraw the excess deferral for 2005 by April 15, 2006, it is includable in your gross income for 2005, but not for 2006. However, any income earned on the excess deferral taken out is taxable in the tax year in which it is taken out. The distribution is not subject to the additional 10% tax on early distributions.

Excess not withdrawn by April 15. If you do not take out the excess deferral by April 15, 2006, the excess, though taxable in 2005, is not included in your cost basis in figuring the taxable amount of any eventual distributions from the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Also, if the entire deferral is allowed to stay in the plan, the plan may not be a qualified plan.

Reporting corrective distributions on Form 1099-R. Corrective distributions of excess deferrals (including any earnings) are reported to you by the plan on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Refer to Publication 525, Taxable and Nontaxable Income, for more information about limits on your elective deferrals.

[BOB W]

Jan....

... please look at page 10> first column 401K must be fixed by 2 1/2 months ( March 15)

http://www.irs.gov/pub/irs-pdf/p525.pdf

Believe me> it is better to fix the problem before the year ends and before it gets to the W-2

[Unregistered]

Thanks Bob,

I was just taking this from the IRS/GOV web site

http://www.irs.gov/retirement/participant/article/0,,id=151786,00.html

[BOB W]

Leave it the IRS.....

...... to not know what the left hand and right hand are doing.....

Both resources seem to cover the same time period ( as well as 401K's) and appear to be current. 2 1/2 months has been in effect for as long as I have known. My first familarization with this issue was in 1999 and was in effect for many years before that..

[New York Enrolled Agent]

...... to not know what the left hand and right hand are doing.....

Both resources seem to cover the same time period ( as well as 401K's) and appear to be current. 2 1/2 months has been in effect for as long as I have known. My first familarization with this issue was in 1999 and was in effect for many years before that..

Actually, I don't think the IRS has it wrong this time. The original post addressed excess DEFERRALS as opposed to excess CONTRIBUTIONS. They are different. I believe excess contributions must be removed within 2 1/2 months while excess deferrals must follow the rules Jan posted and be removed by April 15.

[BOB W]

Just got........

.... up > can't digest the difference. See you later........

?????????????????????????????????????????????????? ???????????????????????

Well, now I'm awake and I still can't see the difference.