The short answer is yes. I find it hard to believe, but it is possible to contribute too much.
I have been fascinated with this topic ever since it came across my desk a few years ago when a client came to me with a letter from her plan administrator letting her know she had over contributed. We both immediately thought, but wait…
Wouldn’t my plan just stop my contributions once I hit the maximum threshold?
I have found that, it depends.
The employer I used to work for would automatically cap my contributions at the maximum amount and update my paychecks accordingly without me having to lift a finger.
However, that process of automatically stopping contributions once they hit the threshold is not a universal and guaranteed offering. In other words, we cannot assume that every single employer plan or plan administrator will have the ability to prevent us from over contributing beyond the IRS limits.
So we need to either confirm whether or not our plan administrator will cap our contributions for us or will we be responsible for keeping track.
The IRS Maximum Allowable Contributions
Per the IRS Guidelines, specific to employer provided retirement plans (401K, 403(b), 457):
- For 2021, the maximum allowable contribution is $19,500, with a $6,500 catch up for those age 50 or older
- For 2022, the maximum allowable contribution is $20,500, and a $6,500 catch up for those age 50 or older.
Common Scenarios That Increase The Likelihood of Over Contributing
A few scenarios that may increase the likelihood of over contributing to your 401K and worth looking into would be one of the following:
- You switched jobs or your employer switched plans at some point in the year. You opened up a new 401K account and lost track of how much you contributed to the previous plan.
Even if the new employer plan had the capability of capping your contributions at the IRS limit – they are not aware of your contributions made earlier in the year to your previous employer plan. - If you work two different jobs that offer an employer provided retirement plan and you are contributing to both.
Even if both your employer plans had the capability of capping your contributions at the IRS limit – they are not aware of any other contributions made to other employer plans. The maximum retirement contribution is per person, not per plan. - Less likely, but if your plan does not cap your deferrals to your retirement account and you received a significant raise or bonus in the year, you may find yourself in a position of over contributing.
- If you contribute to both a Roth 401K and Traditional 401K through your employer. This will add another layer of necessary oversight and review for your payroll and plan administrator and could lead to a disconnect that would result in you over contributing.
What To Do If You Have Contributed Too Much
If you have contributed beyond the IRS limits within the year, below are the following steps you would need to take per the IRS guidelines.
The first thing you would want to do is address the “excess deferral” with your plan administrator and request that the excess be distributed to you. This is time sensitive.
If the excess is distributed to you by April 15th of the following year
The distribution would be income to you and would be included in your previous year taxable income and taxed at ordinary income rates.
You would also be responsible for paying the tax on any earnings from the excess contribution. The earnings would be taxed in the year of distribution.
As an example;
If you over contributed $500 to your 401K plan for 2021, you would have until April 15, 2022 to discuss with your plan administrator, receive your excess deferral and update any W-2 generated for 2021 to reflect the accurate contribution and income amounts. You would then receive a 1099R for 2022 as it relates to any income earned from the excess deferral.
If the excess is NOT distributed to you by April 15th of the following year
If you are not made aware of your excess contribution before April 15, this may result in double taxation.
Once you notify your plan administrator, you will receive a distribution of your excess deferrals. This will trigger the need for an amended W-2 form for the previous year that will require you to amend your previously filed tax return. The amended return will reflect a higher taxable income and thus increasing your tax bill.
In the following year you will also receive Form 1099R identifying a distribution in the full amount from your retirement plan. This too, will be taxed to you in the amount of the distribution.
A Few Suggestions
Whether you are on the verge of contributing too much to your retirement plan or not, I would try to make it a habit to look at your contributions into your retirement account twice a year. Assess how much you have contributed, do you have the opportunity to do more and are you on track to meet your personal contribution goals.
If you are currently contributing to an employer retirement plan and are close to the maximum contribution limits, check in with your HR team or plan administrator directly to get an understanding if you will be capped when you meet that threshold or if you are responsible for keeping track of this yourself.
For those individuals who receive bonuses, especially at the end of the calendar year, check in with where your current retirement contributions are for the year and ensure that this bonus and your percentage contribution to your 401K will not take you over the contribution limit.
Another Friendly Reminder to Be Your Own Financial Advocate
This is another perfect example of the importance of taking ownership of your financial life and being a financial advocate for yourself. Getting an understanding of your options, your restrictions, and how certain financial decisions will impact you.
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