Over Funding Solo 401k Kerfuffle

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Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Over Funding Solo 401k Kerfuffle

Post by letahl »

In March 2021 when doing my taxes for 2020 my accountant determined I made ~$13,000 too much in contributions to my ER side of my Solo 401k (over what my income warranted). I contacted Vanguard, they sent me a form which I signed. They sent me a check which I deposited for the excess contributions and earnings (~$14,500).

In May 2022 when doing my taxes for 2021 my accountant noticed the check pulled the excess contributions from my EE. I contacted Vanguard. Apparently the process that was followed was for funding past the $57,500 limit which was not at issue. I am not sure whose fault it was beyond mine for not knowing.

I also contributed a small amount over for 2021 (~$3,000), which I know now I carry over into the following tax year and send the IRS a check for the 10% penalty with my Form 5330.

The problem are the forms given how the 2020 excess contribution was handled. Vanguard says that since I cashed the check the ship has sailed on getting that money back into the Solo 401k in any way. Fine. So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?

If I'm looking at this right, my next question is - but what do I do about this, now I know, improper withdrawal from my EE side? Why did Vanguard send me a $14,500 check from my EE side? They did say the form was clear that the excess was paid into ER and that they are required to disburse overfunding from the EE side, which seems correct now, so I do not believe they made an error. (Well, unless it was providing the wrong form in March 2021, but there's nothing I can do about that now, it's the administrator's job to know what is happening with the plan.)

Thanks for helping to educate the plan's dumbheaded but learning administrator.
User avatar
MP123
Posts: 2773
Joined: Thu Feb 16, 2017 3:32 pm

Re: Over Funding Solo 401k Kerfuffle

Post by MP123 »

letahl wrote: Tue Jun 21, 2022 8:35 am So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?
You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Re: Over Funding Solo 401k Kerfuffle

Post by letahl »

MP123 wrote: Tue Jun 21, 2022 12:45 pm
letahl wrote: Tue Jun 21, 2022 8:35 am So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?
You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
I was fully funded in EE side in both 2020 and 2021. I think this means your suggestion isn't possible (unless you are suggesting to both roll over to 222 AND recharacterize which I don't think helps). Right?
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MP123
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Re: Over Funding Solo 401k Kerfuffle

Post by MP123 »

letahl wrote: Tue Jun 21, 2022 1:41 pm
MP123 wrote: Tue Jun 21, 2022 12:45 pm
letahl wrote: Tue Jun 21, 2022 8:35 am So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?
You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
I was fully funded in EE side in both 2020 and 2021. I think this means your suggestion isn't possible (unless you are suggesting to both roll over to 222 AND recharacterize which I don't think helps). Right?
I'm suggesting that you might be able to recategorize the excess ER contribution to make it excess EE, then remove it (which you've already done). So you'd end up with a full EE deferral and the correct ER contribution.
Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Re: Over Funding Solo 401k Kerfuffle

Post by letahl »

MP123 wrote: Tue Jun 21, 2022 1:52 pm I'm suggesting that you might be able to recategorize the excess ER contribution to make it excess EE, then remove it (which you've already done). So you'd end up with a full EE deferral and the correct ER contribution.
💡

I gotcha! It sounds like it's probably too late, but it doesn't hurt to explore and see!
SuzBanyan
Posts: 1154
Joined: Thu Jun 02, 2016 11:20 am

Re: Over Funding Solo 401k Kerfuffle

Post by SuzBanyan »

My understanding is that you cannot remove an excess employer contribution to a Solo 401k except in extremely limited circumstances. So when the excess plus earnings were returned to you, they had to come from the employee deferral, which is what Vanguard did.

The good news is, that Vanguard only reports a total to the the IRS. If the employee deferral and employer contribution in total were an allowed amount, the IRS may never know that it was an excess employer contribution that caused the problem. Please note that if you are taxed as a S corp and the employee deferral comes from your paycheck, then this mismatch will be apparent to the IRS. It would also be a problem if the employee deferral was made to a Roth 401k account. Also, note that this is not an authorized method to correct an excess employer contribution and could create further problems with your plan, including possible disqualification, in the future.

Given that you have already removed excess funds from the 401k, this action is probably in lieu of paying the excise tax and filing form 5330 for 2020. But, yes, you would need to file and pay the excise tax (without removing the excess contribution) for 2021. Is there any chance that the 2021 excess was made in 2022 and you could just treat it as a 2022 employer contribution? That would eliminate the need to pay the excise tax.

This is complicated enough that you should probably consult with an attorney or COA with expertise in this area.

There is some helpful information in this thread, particularly from Spirit Rider: viewtopic.php?t=183100

Finally, it probably goes without saying, you need to stop doing this. Most sole proprietors don’t make full employer contributions until after finalizing their tax returns.
Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Re: Over Funding Solo 401k Kerfuffle

Post by letahl »

MP123 wrote: Tue Jun 21, 2022 1:52 pm
letahl wrote: Tue Jun 21, 2022 1:41 pm
MP123 wrote: Tue Jun 21, 2022 12:45 pm
letahl wrote: Tue Jun 21, 2022 8:35 am So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?
You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
I was fully funded in EE side in both 2020 and 2021. I think this means your suggestion isn't possible (unless you are suggesting to both roll over to 222 AND recharacterize which I don't think helps). Right?
I'm suggesting that you might be able to recategorize the excess ER contribution to make it excess EE, then remove it (which you've already done). So you'd end up with a full EE deferral and the correct ER contribution.
Vanguard was happy to do it this way. You just saved me a few thousand bucks and a lot of headache. Thanks so much.
Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Re: Over Funding Solo 401k Kerfuffle

Post by letahl »

SuzBanyan wrote: Tue Jun 21, 2022 7:36 pm My understanding is that you cannot remove an excess employer contribution to a Solo 401k except in extremely limited circumstances. So when the excess plus earnings were returned to you, they had to come from the employee deferral, which is what Vanguard did.

The good news is, that Vanguard only reports a total to the the IRS. If the employee deferral and employer contribution in total were an allowed amount, the IRS may never know that it was an excess employer contribution that caused the problem. Please note that if you are taxed as a S corp and the employee deferral comes from your paycheck, then this mismatch will be apparent to the IRS. It would also be a problem if the employee deferral was made to a Roth 401k account. Also, note that this is not an authorized method to correct an excess employer contribution and could create further problems with your plan, including possible disqualification, in the future.

Given that you have already removed excess funds from the 401k, this action is probably in lieu of paying the excise tax and filing form 5330 for 2020. But, yes, you would need to file and pay the excise tax (without removing the excess contribution) for 2021. Is there any chance that the 2021 excess was made in 2022 and you could just treat it as a 2022 employer contribution? That would eliminate the need to pay the excise tax.

This is complicated enough that you should probably consult with an attorney or COA with expertise in this area.

There is some helpful information in this thread, particularly from Spirit Rider: viewtopic.php?t=183100

Finally, it probably goes without saying, you need to stop doing this. Most sole proprietors don’t make full employer contributions until after finalizing their tax returns.
Clearly! That first year it was pure idiocy/overenthusiasm, and last year it was based on an estimate I was provided which turned out to be an overestimate, but now I'll just wait until the taxes are done. Although I think that means I will have to do them on time without an extension haha.

Vanguard has agreed to move BOTH excess contributions (2020 and 2021) from ER to EE, and as MP123 pointed out I already (inadvertently) fixed 2020 on EE side, so now I just have to fix it on 2021 since it was already maxed. And LEARN MY LESSON well.

No S-corp here, thank goodness. If I had been qualified to handle the paperwork I would've just been DISqualified by this whole thing.

Thank you for this information as to reporting. It's helpful and I'm passing it along to the accountant as well.
User avatar
MP123
Posts: 2773
Joined: Thu Feb 16, 2017 3:32 pm

Re: Over Funding Solo 401k Kerfuffle

Post by MP123 »

letahl wrote: Wed Jun 22, 2022 4:45 pm
MP123 wrote: Tue Jun 21, 2022 1:52 pm
letahl wrote: Tue Jun 21, 2022 1:41 pm
MP123 wrote: Tue Jun 21, 2022 12:45 pm
letahl wrote: Tue Jun 21, 2022 8:35 am So, I believe I have to file two form 5330s - one for each tax year at issue. And I believe for the 2020 excess contribution I pay 10% twice since I'm just now realizing it wasn't fixed. I am thinking even though I deposited a check thinking it was the excess contribution from 2020 that it wasn't, so I file two form 5330s - one for 2020 where I pay 10% on the $13,000 and another for 2021 where I pay 10% on the $16,000 ($13,000 from 2020 and $3,000 from 2022). That puts me effectively paying 10% twice on the 2020 error. I think that's right but would love to be wrong. But - is that right?
You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
I was fully funded in EE side in both 2020 and 2021. I think this means your suggestion isn't possible (unless you are suggesting to both roll over to 222 AND recharacterize which I don't think helps). Right?
I'm suggesting that you might be able to recategorize the excess ER contribution to make it excess EE, then remove it (which you've already done). So you'd end up with a full EE deferral and the correct ER contribution.
Vanguard was happy to do it this way. You just saved me a few thousand bucks and a lot of headache. Thanks so much.
Glad to hear it, and thanks for the update!
Topic Author
letahl
Posts: 140
Joined: Fri Apr 19, 2019 9:17 am

Re: Over Funding Solo 401k Kerfuffle

Post by letahl »

MP123 wrote: Wed Jun 22, 2022 5:38 pm
letahl wrote: Wed Jun 22, 2022 4:45 pm
MP123 wrote: Tue Jun 21, 2022 1:52 pm
letahl wrote: Tue Jun 21, 2022 1:41 pm
MP123 wrote: Tue Jun 21, 2022 12:45 pm

You might check with Vanguard and see if they can recategorize part of the ER contribution as EE. I think they can do that in some cases if it's requested timely, I'm not sure at this point though. If so then you have an easy solution since dealing with an excess EE deferral is easy and you've already done it (even if you didn't mean to).

If not then I think your only option is to pay the excise tax on 5330 until you undercontribute enough (as ER) for a year that you absorb the excess contribution. In other words, apply the excess towards a future year's contribution, paying the 10% along the way. As far as I know there's no other way of dealing with an excess ER contribution, unless you can recategorize it as EE and then withdraw it.
I was fully funded in EE side in both 2020 and 2021. I think this means your suggestion isn't possible (unless you are suggesting to both roll over to 222 AND recharacterize which I don't think helps). Right?
I'm suggesting that you might be able to recategorize the excess ER contribution to make it excess EE, then remove it (which you've already done). So you'd end up with a full EE deferral and the correct ER contribution.
Vanguard was happy to do it this way. You just saved me a few thousand bucks and a lot of headache. Thanks so much.
Glad to hear it, and thanks for the update!
Also it increased my ability to contribute to the employer side by $14k so I'm sending you a metaphorical fruit basket. 🥭🥥🍇🍉🍊🍑🍐🧺
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