Excess 401(k) contributions typically happen when you change jobs. The second employer may not be aware of how much you’ve already contributed with your first employer unless you inform them, and their payroll software supports this configuration option. An excess 401(k) contribution won’t occur with a single employer because the payroll software will stop automatically once you’ve reached the maximum.

If this has already happened, then we need to address it. The following is a list of scenarios, which vary depending on when you identify the problem. Let’s use an example where the taxpayer has overcontributed $1000 to their 401(k), with earnings of $50, in the year 2020.

  • If $1050 is withdrawn before 12/31/2020:
    • Pay tax on $1000 as W-2 income in 2020
    • Pay tax on $50 as a 1099-R distribution in 2020
    • No penalties incurred
  • If $1050 is withdrawn before 04/15/2021:
    • Pay tax on $1000 as W-2 income in 2020
    • Pay tax on $50 as a 1099-R distribution in 2021
    • No penalties incurred
  • If $1050 is withdrawn after 04/15/2021 in year X, when permissible (upon reaching retirement age):
    • Pay tax on $1000 as W-2 income in 2020
    • Pay tax on $1050 as a 1099-R distribution in year X (double tax on $1000)
    • Pay a 10% penalty on $1050 if it’s an early distribution in year X

On the other hand, if a taxpayer overcontributes $1000 to their 401(k), with a LOSS of $50, in the year 2020:

  • If $950 is withdrawn before 12/31/2020:
    • Pay tax on $1000 as W-2 income in 2020
    • No penalties incurred
  • If $950 is withdrawn before 04/15/2021:
    • Pay tax on $1000 as W-2 income in 2020
    • No penalties incurred
  • If $950 is withdrawn after 04/15/2021 in year X:
    • Pay tax on $1000 as W-2 income in 2020
    • Pay tax on $950 as a 1099-R distribution in year X (double tax on $1000)
    • Pay a 10% penalty on $950 if it’s an early distribution in year X

If you have withdrawn the excess in the following year before the filing deadline, you will receive a 1099-R in the subsequent year with codes P and 8:

  • Code P: The principal, which should be added to the previous year by amending the return.
  • Code 8: The earnings, which should be added to the current year.

However, an experienced tax advisor can help you avoid amending the return by preloading the information, saving you cost, penalty, and interest.

If you’re unable to timely withdraw the excess contribution to your 401(k), it must remain in the account until you’re eligible to take distributions, such as at retirement. The excess amount will be taxed twice - once in the year of the contribution (since it’s not deductible) and again when you withdraw it later. This double taxation is the only consequence of the error. Unlike excess IRA contributions, 401(k) excess deferrals are not subject to a 6% excise tax each year they remain in the account.

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