What Is an Overcontribution?
The term overcontribution refers to any amount that a taxpayer contributes to a tax-deductible retirement plan that exceeds the maximum allowable contribution for a given period. Contribution limits are determined and regularly adjusted by a retirement plan's registrar or the Internal Revenue Service (IRS). Overcontributing to your retirement plan can trigger penalties if taxpayers don't deal with the excess amounts within a certain period of time.
Key Takeaways
- An overcontribution is any amount that someone sets aside to a tax-deductible retirement plan that exceeds the maximum allowable contribution for a given period.
- The IRS imposes a 6% penalty for each year that any excess amount contributed remains in a retirement account until it is rectified.
- Taxpayers can withdraw the excess and related earnings or apply it to a future year's contribution.
- Plan holders should notify the plan administrator or their employer to begin fixing the problem.
- Employer-sponsored plans require that amended W-2 forms be issued to employees.
Understanding Overcontribution
The IRS sets limits on how much taxpayers can invest each year in their retirement savings accounts. The agency imposes different limits for different plans and adjusts them annually for inflation. For instance, individual taxpayers can contribute a maximum of:
- $22,500 in 2023 ($23,000 in 2024) to a 401(k), 403(b), or profit-sharing plan. People 50 and older can make an additional catch-up contribution of $7,500 in 2023 and 2024.
- $6,500 in 2023 ($7,000 in 2024) to an individual retirement account (IRA) with an additional $1,000 per year for those 50 and older.
- $66,000 in 2023 ($69,000 in 2024) to a Simplified Employee Pension (SEP) IRA
- $15,500 in 2023 ($16,000 in 2024) to a SIMPLE IRA
Although it's important to max out your contribution limits, don't go overboard. Any amount you invest in these accounts above the limits is considered overcontributions. As such, they're ineligible for any tax breaks you may receive—like those associated with IRAs, which reduce your tax bill. In fact, overcontributions run the risk of costing you more money in the tax year they're made.
The IRS imposes a 6% penalty on the amount of the excess every year until you fix the situation. And any excess contributions made toward an IRA cannot be used to reduce your taxable income. Here's what you can do to fix the situation:
- You have until the tax filing deadline of that year (generally April 15) to withdraw the excess and any related earnings. The earnings on that excess must be reported as income on your tax return.
- You may apply the excess to the following year's contribution limit. But this means that you'll have to pay the 6% penalty in the current year.
The limits to employer-sponsored plans like a 401(k) only apply to employee contributions, such as those made through payroll deductions. Any matches from employers do not count toward overcontributions.
Special Considerations
Be sure you notify your plan administrator or employer if you breach the IRS limit for your 401(k), 403(b), IRA, or any other kind of retirement account. The earlier you make the notification the year after the overcontribution, the better. It’s up to the plan administrator to return any excess payments to employees (in the case of an employer-sponsored plan), as well as any earnings on the excess contributions.
Sending this notification as early as possible provides plan administrators enough time to do the necessary paperwork—especially when the plans are held through an employer. This typically includes adjusting any contributions that came out of employees' checks on a pretax basis and counting them as wages on employees' W-2 forms. This allows employees enough time to issue new forms before the annual tax filing deadline.
Risks of Overcontribution
As noted above, it's important to correct overcontributions quickly. Otherwise, tax trouble often ensues. If the excess amount is not returned to affected employees in enough time to file taxes, employees run the risk of double taxation. That is, they could pay taxes in the year the excess occurred, and still need to pay the following year, as well.
To avoid double taxation, some employees can file an amended return with the excess contribution taken out, plus any related earnings from the overcontribution. This must be done by the due date for tax returns in April.
Overcontributions to IRAs are a bit easier to correct but they still result in penalties. Those who overcontribute to an IRA can leave their accounts alone and designate any overcontribution toward next year’s limit. Remember, that a 6% penalty applies on any excess per year. Of course, any individual contributions must be adjusted going forward to keep from again creating an overcontribution the following year.
How Do You Handle a 401(k) Overcontribution?
If you've overcontributed to your 401(k) account, contact your plan administrator and notify them of the overcontribution. Try and do this before the annual tax-filing deadline. Your plan administrator will then return the amount and adjust the earnings.
What Happens If I Overcontribute to My IRA?
If you overcontribute to your IRA, you will have to pay a 6% penalty every year on the additional amount until it is corrected.
How Much Money Can You Roll Over Into an IRA?
The IRA contribution limit does not apply to rollovers. For example, if you have a 401(k) from an old job you can rollover the entire account into an IRA.
