Excess After-Tax Contribution Correction - Need Help

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Topic Author
Baron_Vladimir
Posts: 3
Joined: Wed Dec 30, 2020 7:17 pm

Excess After-Tax Contribution Correction - Need Help

Post by Baron_Vladimir »

Hello Everyone,

My employer's 401K plan allows after-tax contribution and in-service withdrawals (to a Roth IRA). I keep tracking both employee and employer contributions so not to exceed the $57,000 limit for 2020, however, I made a mistake not realizing the 1/1/21 paycheck would be paid out on 12/31/20 rather, thus going over the limit. What made the condition immensely worse, is that I have already rolled over all of the previous after-tax contribution along with earnings to a Roth IRA at a different custodian. And due to employer match, there would be insufficient funds to return the excess contribution.

In terms of the correction, my understanding is that I need to:
1) Ask the 401K custodian to determine the excess contribution (A) and earnings (B); and return all funds in after-tax account (C);
2) D = A+B-C would be the excess Roth IRA contribution;
3) Ask the Roth IRA custodian to calculate the earnings (E) on D, and return D+E; I need to pay 10% penalty on E;
4) Deal with perhaps three 1099-Rs in April;

Is this correct?

Alternatively, can I wait until there is enough after-tax funds (with additional 2021 contributions in a couple of weeks), and withdraw A+B from 401K therefore avoiding having to deal with the rolled-over-to-Roth-IRA mess?

Thanks very much!
Last edited by Baron_Vladimir on Fri Jan 08, 2021 11:44 am, edited 1 time in total.
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celia
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Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Excess After-Tax Contribution Correction

Post by celia »

It seems to me that the 401K administrator should be checking that the participants don't go over the max they can contribute. I'd start by talking to them. It is possible the first deposit of 2020 was for the previous year. If not, have the administrator first confirm that you over-contributed and see what they suggest.

Don't attempt a withdrawal on your own, since it will probably be coded as an early withdrawal or something. THEY need to calculate and take the amount out for you while coding the transaction properly.
Topic Author
Baron_Vladimir
Posts: 3
Joined: Wed Dec 30, 2020 7:17 pm

Re: Excess After-Tax Contribution Correction

Post by Baron_Vladimir »

Thanks Celia. You are definitely correct that the corrective distribution should be initiated by the 401K custodian.

What’s interesting and annoying is that the additional contribution that pushed me over the limit, from the 12/31/20 paycheck, just posted in the 401K today. But my understanding is that it still counts towards last year :(

Could anybody please help verify the (il)legality of my proposed alternative approach, where I essentially use 2021 contributions to fund the 2020 return-of-excess-contribution? Much obliged!
Alan S.
Posts: 10202
Joined: Mon May 16, 2011 6:07 pm
Location: Prescott, AZ

Re: Excess After-Tax Contribution Correction - Need Help

Post by Alan S. »

Baron_Vladimir wrote: Wed Dec 30, 2020 8:09 pm Hello Everyone,

My employer's 401K plan allows after-tax contribution and in-service withdrawals (to a Roth IRA). I keep tracking both employee and employer contributions so not to exceed the $57,000 limit for 2020, however, I made a mistake not realizing the 1/1/21 paycheck would be paid out on 12/31/20 rather, thus going over the limit. What made the condition immensely worse, is that I have already rolled over all of the previous after-tax contribution along with earnings to a Roth IRA at a different custodian. And due to employer match, there would be insufficient funds to return the excess contribution.

In terms of the correction, my understanding is that I need to:
1) Ask the 401K custodian to determine the excess contribution (A) and earnings (B); and return all funds in after-tax account (C);
2) D = A+B-C would be the excess Roth IRA contribution;
3) Ask the Roth IRA custodian to calculate the earnings (E) on D, and return D+E; I need to pay 10% penalty on E;
4) Deal with perhaps three 1099-Rs in April;

Is this correct?

Alternatively, can I wait until there is enough after-tax funds (with additional 2021 contributions in a couple of weeks), and withdraw A+B from 401K therefore avoiding having to deal with the rolled-over-to-Roth-IRA mess?

Thanks very much!
If the 12/31 paycheck is fully included in 2020 figures, might your after tax contributions made on that date be enough to cover your excess over 57k? If so, the plan will be able to issue the corrective distributions soon. However, if the funds in the account are still lacking, that sets up different options for the plan to address this. Some of those options may be:
1) Since the after tax sub account has been basically drained, the plan can correct the excess annual addition by using your elective deferrals for the correction. That's not good news because distribution of pre tax elective deferrals and their earnings would both be taxable on your 2021 return. There is no 105 penalty though.
2) The plan might take the position that your Roth rollover included excess amounts even though you did the rollover prior to creating the excess. That would trigger two 1099R forms for 2020, one showing the allowed Roth rollover amount, and another to show the excess plus earnings. Only the earnings would be taxable, but the corrective 1099R will result in an excess Roth IRA contribution since an amount not eligible for rollover was rolled into the Roth IRA. The Roth IRA custodian would have to be told about the excess amount and would treat it as an excess regular Roth contribution.
3) I hope that the plan does not fail any of the discrimination tests in addition, since that will make the excess into a two headed monster. Both violations would have to be corrected. Have you received excess contributions back in the past, perhaps by failing the ACP test?

I don't think the plan can use your 2021 after tax contributions to correct the 2020 error, but am not totally sure.

Celia is correct that the plan should have known for months that any 1/1 paychecks would default to 2020 contributions and taxable income. If they had provided a heads up, they might have been able to avoid some of the violations. Many plans do not allow you to make after tax contributions right up to the 57000 limit (goes to 58000 for 2021), since that increases the chance for excess annual additions (Sec 415c), failed ACP tests, or unpredictable forfeitures to your account causing infractions.

In about two weeks, the 1099R for your Roth rollover should be issued. If it shows the full amount of the rollover on a G coded 1099R, that may be an indication that they will not be issuing another corrective 1099R (Code E) for 2020. Otherwise, it is unlikely that you will be given a choice on how this is reconciled by the plan administrator and will have to deal with what they come up with. Hopefully, they will not use elective deferrals to correct this, as that is probably the only solution that would generate meaningful taxes due. The other options are not very costly, just a reporting hassle.
Topic Author
Baron_Vladimir
Posts: 3
Joined: Wed Dec 30, 2020 7:17 pm

Re: Excess After-Tax Contribution Correction - Need Help

Post by Baron_Vladimir »

Thanks very much for the analysis and explanation Alan. One point made clear by you and also mentioned by Celia, which is perhaps obvious but I'm only starting to see now, is that I actually have very little say in this matter, and it's the 401K custodian who would dictate how the correction is carried out. 8-)

A bit extra information:
1. Due to employer contribution, in addition to my after-tax portion, included in the 12/31 paycheck, there aren't sufficient after-tax funds to cover the correction.
2. The gap, according to my calculation, is not too much. Therefore, if they decide to use my elective deferrals for the correction, I think I can live with that.
3. However, if I have to return the excess Roth-IRA roll-over, then as you said, I guess I'll just have to deal with the reporting hassle.
4. I have never received excess contributions back so far, however, I understand it's always a possibility. One odd thing related to this is that the plan appears to allow in-service withdrawal and subsequent roll-over to a Roth-IRA, but not In-plan-Roth-Rollover, with which I hoped any correction process would be less messy.

Again, thanks for your kind help. I'll report back how they want to clean up my mess.
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