401k deferrals to 2 plans
A new client has made the maximum deferral into the 401k plan of 2 unrelated employers for 2009. They need to notify one of them and have the deferral plus earnings refunded to them. What are the additional consequences of this refund not being done by the due date of the 09 return? I assume they will need to claim the income on an amended 09 return, as additional wages, based on corrected doc’s being issued by the employer. Has anyone else handled a case like this and how did it play out?
Permalink Submitted by Alan Spross on Wed, 2010-10-27 02:53
These are known as excess elective deferrals. The client can select which plan to approach for the distribution but a plan is allowed to include provisions disallowing the distribution.
1) If distribution cannot be made from either plan, the excess amount must be included in income for the year of deferral (excluding designated Roth deferrals). There is no basis assigned to either plan and therefore the excess amount that was included in income will be taxed again when eventually distributed down the road.
2) If the excess is distributed by 4/15 of the following year, it is included in income only for the year contributed, not the year received, but the allocated income is taxable in the year received. This avoids double taxation. If it is distributed after 4/15 it must be included in income in the year received as well as the year of the deferral. Once received it is NOT eligible for any rollover.
If the excess is not received by 4/15, it is better to rescind the request and let it ride so that the added deferral can generate tax deferred income for years. There are no penalties for letting the excess ride, except for the eventual double taxation. But if the second tax bill is a few decades away, the contribution could generate considerable additional earnings while the second tax is deferred.
1099R forms will contain distribution codes clarifying in which year the income is to be reported.
My impression is that most plans will refund the excess, but no guarantees there.
Permalink Submitted by Tim Zheng on Sat, 2013-01-12 06:27
In the previous situation, if the tax payer is terminated from one of the jobs but the plan won’t distribute the excess, can’t he just rollover this excess amount into an IRA, and then request a return of excess contribution from the IRA? Will this solve the problem? Any issue this way?
Permalink Submitted by Alan - IRA critic on Sat, 2013-01-12 21:36
Did you post this question on another site? I recall addressing the issue but don’t think it was concluded. Note that you are apparently resigned to the excess deferral being added to your 2012 line 7 income, but want to get the funds and earnings back to you will not be taxed a second time. A qualified plan must return the excess no later than 4/15 for you to avoid future double taxation, but this is optional and the current employer is much more likely to comply than a former employer. That would cost you earnings gains in the current employer plan. An UNCORRECTED excess deferral is eligible for IRA rollover, so you could do a direct rollover of the old plan to an IRA. Then your problem becomes convincing the IRA custodian that this is excess deferral money so they should code the distribution as an excess IRA rollover contribution. That may be difficult enough, but you will still have to explain to the IRS what you did and why you are not paying taxes on the IRA 1099R (except for earnings on the excess deferral). If the IRA custodian refuses, you just get a normal taxable IRA distribution, and you still need to document and explain this transaction on your tax return. It is difficult to determine your chances of success, even with complete documentation. Compare that option with simply keeping the IRA rollover, getting decades of tax deferral and gains, and eventually paying the double tax very gradually in retirement.
Permalink Submitted by Tim Zheng on Sat, 2013-01-12 23:16
Yes, I posted the question on bogleheads. Anyway, I do see that it complicates things more to rollover to IRA and try distribute there. Now I’m thinking about going back to my original thinking, which is to take a lump sum cash distribution from the 401k plan. Then I’ll figure out how much should be corrective distribution of excess deferral and its earnings. I’ll treat that amount of cash as the corrective distribution and just keep the cash. The rest amount from the lump sum I treat as rollover and put into my IRA. I’ll easily be able to fund the 20% withholding until I get it back next year.The 401k plan will issue 1099R and code it as early withdrawal. I’ll treat it part as indirect rollover and part as corrective distribution, very similar to how indirect 401k rollovers are treated commonly.
Permalink Submitted by Alan - IRA critic on Sat, 2013-01-12 23:40
If you are going to keep your own calculation of the excess deferral and it’s earnings, why not ask the plan to do a direct rollover of the rest of the balance and that will avoid 20% withholding on that portion. There will be two 1099R forms, one for the direct rollover coded G, and the other for the distribution to you. This keeps the disputed amount separate from the rest of the account. I would still make one final appeal for the plan to distribute the excess deferral using the proper coding as that would eliminate all problems with the IRS. Attempting to convince the IRS you did your own corrective distribution will be challenging, but nothing lost by trying. If they don’t agree, you also get hit with the 10% penalty as well as tax in 2013 for even more (Due to earnings) than the amount added to your income for 2012. Note – if you are going to try to calculate your own earnings, it must include the period up to the date of distribution (the earnings from 1/1 to distribution date is called the “gap period earnings”.