IRC Sec. 402(g) Excesses Explained
By Doreen Happke, QKA, CHSP
Plan administrators and plan participants must limit the elective deferrals that are contributed to their qualified retirement plans each calendar year to the Internal Revenue Code Section (IRC Sec.) 402(g) limit. The limit includes elective deferrals (including both pretax and designated Roth deferrals) that participants can defer into their qualified retirement plans (in aggregate) for each taxable year. The Internal Revenue Service (IRS) may increase the limit in subsequent years for cost-of-living adjustments. When elective deferrals exceed the IRC Sec. 402(g) limit they become “excess deferrals”. Excess deferrals must be removed from the plan. From a plan compliance standpoint, it’s important to determine whether excess deferrals are a plan failure or not.
When are excess deferrals considered a plan failure?
Plan administrators are responsible for monitoring their participants’ accounts to ensure they don’t exceed the IRC Sec. 402(g) limit, which is defined in the plan’s adoption agreement. Elective deferrals that exceed the limit within an employer’s plan(s) will result in an operational failure as described in Rev. Proc 2021-30, Appendix A, Section .04. As with any other operational failure, plan administrators should take corrective action. It is noteworthy that even if a plan year is fiscal, rather than calendar, and other plan limits are measured on a fiscal year basis, the IRC Sec. 402(g) limit is measured on a calendar year basis.
How can a plan administrators correct excess deferrals?
If plan administrators determine that a participant has exceeded the IRC Sec. 402(g) limit in a calendar year, the plan administrator may distribute the elective deferrals that exceed the plan limit adjusted for earnings through the last day of the year, returned to the participant by April 15 of the year following the year of the deferral.
If returned by this deadline, the participant will be taxed only on the excess amount during the year of deferral. Earnings on the excess will be taxed in the year of distribution. The normal 10 percent early distribution penalty tax, 20 percent withholding, and spousal consent requirements will not apply to amounts distributed timely.
What happens if plan administrators fail to distribute excess deferrals by April 15?
If excess deferrals are not returned on or before April 15 of the following year, the plan could be subject to disqualification. In this case, the plan administrator must correct the error through the IRS’ Employee Plans Compliance Resolution System (EPCRS).
The participant must pay income tax on excess pretax deferral amounts both in the year of deferral and in the year of distribution. The earnings on the excess will be taxed in the year of distribution. Distributed excess deferrals consisting of designated Roth account assets, however, will only be reported as taxable in the year they are distributed. This is because designated Roth contributions were already taxed in the year of deferral.
Consistent with their taxable status, excess deferrals that are distributed late could also be subject to the 10 percent early distribution penalty tax, 20 percent withholding, and spousal consent requirements.
When are excess deferrals not considered a plan failure?
Participants are responsible for monitoring their qualified retirement plan accounts to ensure they don’t exceed the IRC. Sec. 402(g) limit, which is defined in the plan’s adoption agreement. Participants who are in more than one unrelated retirement plan must ensure that they do not exceed the IRC Sec. 402(g) limit (in aggregate) for each calendar year. If an excess deferral does occur due to aggregate deferrals into plans of unrelated employers, it is not considered to be a plan failure because the unrelated employers would have no way of knowing what the participant was contributing to an unrelated plan.
How can a participants correct such excess deferrals?
The participant must submit a claim requesting that the excess amount (including earnings) be distributed by the participant’s tax return due date. Generally, participants must notify their plan administrator in writing by March 1 and distribute the excess by April 15 of the year following the year of the deferral. But, because this is not a plan failure, the excess deferral may not be distributed until the participant incurs a distributable event.
What happens if the participant fails to distribute the excess deferral by April 15?
According to the IRS, if an excess deferral is not distributed timely, it is included in the participant’s taxable income for the year of deferral and the year of distribution, the latter when there is a distributable event.
Additional information on how to correct excess deferrals can be found in the IRS 401(k) plan fix-it-guide.
