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401(k) Plan Fix-It Guide - Elective deferrals weren't limited to the amounts under IRC Section 402(g) for the calendar year and excesses weren't distributed

 

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7) Elective deferrals weren't limited to the amounts under IRC Section 402(g) for the calendar year and excess deferrals weren't distributed. Inspect deferral amounts for plan participants to ensure that the employee hasn't exceeded the limits. Distribute excess deferrals. Work with plan administrators to ensure that they have sufficient payroll information to verify the deferral limitations of IRC Section 402(g) were satisfied.

Internal Revenue Code Section 402(g) places a limit on the amount of elective deferrals a plan participant may exclude from taxable income each calendar year. IRC Section 401(a)(30) provides that, for a plan to be qualified, it must provide that the amount of elective deferrals for each participant under all plans of the same employer not exceed the 402(g) limits. The limit on elective deferrals under Section 402(g) is:

Limits on the amount of elective deferrals a plan participant may contribute to a SIMPLE 401(k) plan are different than those in a traditional or safe harbor 401(k) plan.

  • SIMPLE 401(k) deferrals are limited to $12,000 in 2013.
  • This limit is subject to cost-of-living increases after 2013.

Catch-up contributions: A plan may permit participants age 50 or over at the end of the calendar year to make additional deferrals. These additional contributions are called catch-up contributions and aren't subject to the general limits that apply to 401(k) plans (see IRC section 414(v)). An employer isn't required to provide for catch-up contributions. However, if your plan does allow catch-up contributions, you must allow all eligible participants to make catch-up contributions.

  • If an employee participates in a traditional or safe harbor 401(k) plan and is age 50 or older:
    • The elective deferral limit increases by $5,500 in 2013.
  • If an employee participates in a SIMPLE 401(k) plan and is age 50 or older:
    • The elective deferral limit increases by $2,500 in 2013.
  • These limits are subject to cost-of-living increases after 2013.
  • The catch-up contribution for a year cannot exceed the lesser of:
    • The catch-up contribution limit, or
    • The excess of the employee’s compensation over the elective deferrals that aren't catch-up contributions.

Catch-up contributions are not subject to the section 401(a)(30) plan qualification rule. 

Elective deferrals include both pre-tax deferrals and designated Roth contributions. Generally, you must consider all elective deferrals made by a participant to all plans in which the employee participates to determine if the employee has exceeded the 402(g) limits. If an employee has elective deferrals in excess of the 402(g) limit under one or more plans of an employer, each plan is subject to disqualification.

Your plan document may place its own, lower limit on the amount of the deferral or on the percentage of pay that participants may defer. Additionally, your plan may need to limit a plan participant’s elective deferrals to meet certain nondiscrimination requirements.

If the total of a plan participant’s elective deferrals is more than the limit under IRC Section 402(g), to avoid failing IRC Section 401(a)(30), the excess amount plus allocable earnings must be distributed to the participant by April 15 of the year following the year of deferral. Excess deferrals not timely returned to the participant are subject to additional tax. 

Timely withdrawal of excess contributions by April 15

  • Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
  • Earnings are taxable in the year they're distributed.
  • There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.

Consequences of a late distribution

  • Under IRC Section 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS.
  • Under EPCRS, these excess deferrals are still subject to double taxation; that is, they're taxed both in the year contributed to and in the year distributed from the plan.
  • These late distributions could be subject to the 10% early distribution tax, 20% withholding and spousal consent requirements.

Excess deferrals distributed to HCEs are included in the ADP test in the year the amounts were deferred. Excess deferrals distributed to NHCEs aren't included in the ADP test if all deferrals were made with one employer. Excess deferrals distributed after April 15 are included in annual additions for the year deferred.

How to find the mistake:

Ensure that no one's elective deferrals exceed the 402(g) limit for a year by comparing the amount deferred to the 402(g) limit. If anyone exceeds the 402(g) limit and it isn't corrected, the plan could be disqualified.

How to fix the mistake:

IRC Section 72(t) imposes a 10% additional tax for distributions that don't meet one of the exceptions, such as death, disability or attainment of age 59 ½, among others. To avoid this additional tax, correct excess deferrals no later than the first April 15 of the following year. If you don't correct by April 15, you may still correct this mistake under EPCRS; however, it will not relieve any Section 72(t) tax resulting from the mistake.

  • Under Revenue Procedure 2013-12, Appendix A, section .04, the permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable both in the year of deferral and in the year distributed. These amounts are reported on Forms 1099-R.

Example:
Employer X maintains a 401(k) plan that has 21 participants. For calendar year 2011, Ann deferred $17,500 to the plan. Ann is under age 50 and isn't eligible to make catch-up contributions. Ann has excess deferrals of $1,000 because $16,500 is the 402(g) maximum amounted permitted for 2011. Employer X didn't discover this mistake until after April 15, 2012. On November 1, 2012, X distributed the excess deferral (plus applicable earnings of $100, totaling $1,100) to Ann.

For 2011 (year of deferral), Ann must include $1,000 in gross income. For 2012 (year of distribution), Ann must include $1,100 in gross income. Employer X would show this amount on a Form 1099-R. In addition, Ann must pay the additional 10% early distribution tax under IRC Section 72(t).

Correction programs available:

Self-Correction Program:
The example illustrates an operational problem, because Employer X failed to follow the plan terms prohibiting any employee’s elective deferrals from exceeding the 401(a)(30) limit. Therefore, if the other eligibility requirements of SCP are satisfied, Employer X may use SCP to correct the failure.

  • No fees for self-correction.
  • Practices and procedures must be in place.
  • If the mistakes are significant in the aggregate:
    • Employer X needs to make a corrective distribution by December 31, 2013.
    • If not corrected by December 31, 2013, Employer X isn't eligible for SCP and must correct under VCP.
  • If the mistakes are insignificant in the aggregate, Employer X can correct beyond the two-year correction period for significant errors. Whether or not a mistake is insignificant depends on all the facts and circumstances.

Voluntary Correction Program:
Correction is the same as described under SCP. Employer X makes a VCP submission according to Revenue Procedure 2013-12. The fee for the VCP submission is $1,000. When making its VCP submission, Employer X must include Forms 8950 and 8951 and should consider using the model documents in Revenue Procedure 2013-12 Appendix C. 

Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described under SCP. Employer X and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction based on the maximum payment amount.

How to avoid the mistake:

  • Work with your plan administrator to ensure that the administrator has sufficient payroll information to verify that the deferral limitations of IRC Section 402(g) were satisfied.
  • Establish procedures to ensure that, based on the participant election forms (including modifications), participants will not exceed the IRC Section 402(g) limit.
  • Have checks and balances in place to alert you and your plan administrator when the limit is exceeded so that timely corrective action can be taken.

401(k) Plan Fix-It Guide
401(k) Plan Overview
EPCRS Overview
401(k) Plan Fix-It Guide (pdf)
401(k) Plan Checklist
Additional Resources

IRS.gov / Retirement Plans / Correcting Plan Errors / Fix-It Guides / Potential Mistake

Page Last Reviewed or Updated: 15-Jan-2014