What happens if your plan allocates too much money to a plan participant’s 401(k) account in a given year? The IRS recently addressed that issue in its periodic “fixing common plan mistakes” guidance series.
The periodically inflation-adjusted Section 415(c) limit on annual additions to a participant’s retirement account covers all five potential contribution sources:
- Elective employee contributions (whether pretax or Roth),
- After-tax employee contributions,
- Employer matching contributions,
- Employer profit-sharing contributions, and
- Any other employer contributions.
For 2018, the maximum employee elective deferral amount is $18,500 (or $24,500 for participants aged 50+), and the Sec. 415(c) limit is the lesser of $55,000 or 100% of the participant’s compensation. Catch-up contributions aren’t counted against the Sec. 415(c) limit. While it’s an uncommon scenario to overallocate, you’ll need to know what to do if it happens.
An illustration will help. Jill works for a company with a typical 50% matching contribution on the first 6% of compensation. She is a 51-year-old employee earning $150,000. Maximizing her own deferrals to her 401(k) account would have put $24,500 of her own earnings into the plan, plus another $4,500 in employer matching contributions. Because her catch-up contribution of $6,000 is not included for purposes of calculating the total available to comply with the Sec. 415(c) limit, the total available amount for any additional employer contributions is $23,000 before she reaches such limit ($18,500 + $4,500 = $23,000).
But what if Jill also received a $20,000 profit sharing contribution, and another $20,000 employer contribution not linked to profits? That combined $40,000, added to the $23,000, would total $63,000 and put Jill $8,000 over the Sec. 415(c) limit.
What needs to happen to that $8,000 excess? According to the IRS, you must distribute unmatched contributions to the affected participant. If any excess remains (there wouldn’t be, in Jill’s case), you then distribute elective contributions that are matched to the participant, and forfeit related matching contributions. If an excess still remains, you must forfeit other profit-sharing contributions.
Once you’ve dealt with the excess, you report the corrective distribution to the participant on an IRS Form 1099-R. The amount is taxable to the participant, but not subject to a 10% premature withdrawal penalty. Finally, you need to transfer any forfeited employer contributions to an unallocated account that can be tapped to help with your obligations to other participants.