Your 401(k) plan helps you save for retirement. But save too much and you'll lose the benefits. Excess contributions are more common when you are eligible to contribute to multiple 401(k) plans in the same year because your employer will usually prevent you from contributing too much to one plan. However, you are ultimately responsible for making sure you don't contribute too much.
Contributions Taxed Twice
When you contribute more than the maximum allowed to your 401(k) plan, you can't exclude the excess from your income in the year you make the contribution. For example, if you contribute $3,000 extra, you must include that $3,000 as taxable income. In addition, even though you already paid taxes on the money, you have to pay taxes a second time on that same money when you take it out of the plan.
The contribution limits for 401(k) plans adjust annually to account for inflation. As of 2012, the maximum you can contribute is $17,000 into all of your plans combined. For example, if you put $17,000 in your 401(k) plan at your first job, any contribution you make to a 401(k) plan at your second puts you over the limit. If you are 50 or older, you can make an additional catch-up contribution, which also adjusts annually. As of 2012, the limit is $5,500.
The 401(k) contribution limit is cumulative with most other defined contribution plans, such as 403(b) plans or simplified employee pension plans. For example, if you contribute $17,000 to your 403(b) plan, anything you contribute to your 401(k) plan exceeds your maximum annual contribution. However, 457 plan contributions are not included when calculating your annual contributions, so you can max out both your 401(k) plan and your 457 plan, if you have both.
Correcting Excess Contributions
You can avoid the double taxation if you withdraw the excess contributions by your tax filing deadline, typically April 15. When you take the distribution, you must include any earnings on the excess contribution. For example, if you contributed $3,000 extra and that $3,000 earned you $100 while it was in the 401(k) plan, you have to withdraw $3,100, not $3,000, to fix your excess contribution. Your 401(k) plan administrator will be able to tell you how much you need to withdraw to account for earnings.
- Comstock/Comstock/Getty Images
- How to Have Back-Up Cash
- Can a Husband & Wife Elect Different Periods for Paying Taxes on a Roth Conversion?
- How Do I Know What a House Is Really Worth Before Making an Offer?
- Which Is Better, a Savings Account or a Money Market Account?
- How Do Bank Money Market Accounts Work?
- Savings Vs. Money Market Account
- What Happens When You Contribute More Than the Maximum Allowed in Your 401(k)?
- Tips for Debit Card Users
- How Interest Works on a Money Market Account
- The Differences Between CDs and Money Market Accounts