Excess contribution to 401K on purpose (is it worth it?)

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Topic Author
sheelu0125
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Joined: Tue Feb 14, 2017 3:32 pm

Excess contribution to 401K on purpose (is it worth it?)

Post by sheelu0125 »

Hi,
I recently switched jobs and my new employer is much more generous than the previous one.
I have contributed $11.5k to my previous employers 401k at Fidelity and received a match of $2.2k.
My new employer matches 50% of my contribution upto the IRS cap (Match of $10,500 if I contribute $20,500 for 2022). The new employer does not prorate the match even if I joined partway through the year(so I can still get the entire 10.5k match). The new plan is at Vanguard.

My dilemna is whether:
1. I should contribute the entire 20,500 to the new plan(thus over contributing on purpose) to get the $10.5k match and then withdraw excess from my old employer
2. I should contribute the entire 20,500 to the new plan(thus over contributing on purpose) to get the $10.5k and then do nothing (i.e. pay taxes on excess twice in order to keep the old employer's match)
3. I should only contribute 9k to the new employer's plan in order to avoid exceeding the 20.5k limit across both plans. I will only be able to collect 4.5k (leaving 6k in match dollars on the table)

Additional info that may be useful to determine the best course of action:
I should add that my new employer's benefits website addresses option 1 and says that I can withdraw excess contributions from my old employer's plan or the new one (they suggested contacting old employer's plan to check if they allow the return of excess contribution and if not, withdraw from the new plan).

Fidelity (old employer's 401k provider) seems to say that I can submit for removal of excess contribution but may require approval from plan sponsor. Also asks for the W2 from both employers while submitting the request. Since I'm still within the plan year, I was wondering if it would be simpler tax wise to do the withdrawal within the year but I won't have the W2 available until next year.

My 401k is invested 80% in SP500 and 20% in international excluding US.
Due to the way the markets have behaved this year, my overall account balance is lower now than the start of the year.

Any thoughts on what I should do?
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squirrel1963
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by squirrel1963 »

In general I think it depends on how much you value tax deferred space. It can be argued that if you have a long investment horizon you are actually better off in paying twice the tax on over contribution (once in 2023, and again when you withdraw X years from now) because you have more money which is growing tax deferred.
In my case tax deferred space is very valuable because I keep a TIPS ladder which is very tax inefficient, so I definitely would have over contributed. I actually accidentally did that last year because new-megacorp payroll ignored previous contributions despite me telling them about old-megacorp.

In your case you are getting company match, so the double taxation on the principal amount will be even lower.

This seems to be an interesting loophole which the IRS allows, even though it's probably unintended. In my case I was actually lazy and did nothing until April 15 of this year, at which point I was told it was just not possible to remove overcontributions. My guess is that so few people max out their 401k contributions that it's not even worth their time in closing it.
LMP | Liability Matching Portfolio | safe portfolio: TIPS ladder + I-bonds + Treasuries | risky portfolio: US stocks / US REIT / International stocks
TropikThunder
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by TropikThunder »

sheelu0125 wrote: Thu Oct 06, 2022 12:55 pm My dilemna is whether:
1. I should contribute the entire 20,500 to the new plan(thus over contributing on purpose) to get the $10.5k match and then withdraw excess from my old employer
2. I should contribute the entire 20,500 to the new plan (thus over contributing on purpose) to get the $10.5k and then do nothing (i.e. pay taxes on excess twice in order to keep the old employer's match)
3. I should only contribute 9k to the new employer's plan in order to avoid exceeding the 20.5k limit across both plans. I will only be able to collect 4.5k (leaving 6k in match dollars on the table)
1. Your old employer is under no obligation to help you by withdrawing the excess (regardless of what Fidelity says about the process) since it's not an excess deferral in their plan. A qualified plan can get in significant trouble if it allows a participant to exceed the deferral cap and doesn't correct it, but that refers to exceeding the cap within that plan, not in aggregate across multiple unaffiliated plans.

2. This would be my choice but you'd need to evaluate the pros and cons between 2 and 3. Maxing out deferral at employer B would mean $11,500 in non-deductible deferrals that would be taxed as regular income when withdrawn. In exchange, you would receive $6,000 in matching contributions. An oversimplified comparison would be: is the tax on the $11,500 non-deductible deferrals more or less than $6,000?

If you're in the 22% marginal bracket for example, you'd pay $2,530 in taxes on $11,500 in income. That's less then the $6,000 match, so it's worth it to exceed the cap.
TropikThunder
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by TropikThunder »

squirrel1963 wrote: Thu Oct 06, 2022 1:06 pm My guess is that so few people max out their 401k contributions that it's not even worth their time in closing it.
I agree, especially since this scenario can only happen when someone changes jobs mid-year.
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squirrel1963
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by squirrel1963 »

TropikThunder wrote: Thu Oct 06, 2022 10:12 pm
squirrel1963 wrote: Thu Oct 06, 2022 1:06 pm My guess is that so few people max out their 401k contributions that it's not even worth their time in closing it.
I agree, especially since this scenario can only happen when someone changes jobs mid-year.
Exactly, so how often this happens? Exceedingly rarely, and my guess this is why also payroll didn't handle my change correctly, they probably don't get enough people like me.
LMP | Liability Matching Portfolio | safe portfolio: TIPS ladder + I-bonds + Treasuries | risky portfolio: US stocks / US REIT / International stocks
Topic Author
sheelu0125
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by sheelu0125 »

TropikThunder wrote: Thu Oct 06, 2022 10:00 pm
sheelu0125 wrote: Thu Oct 06, 2022 12:55 pm My dilemna is whether:
1. I should contribute the entire 20,500 to the new plan(thus over contributing on purpose) to get the $10.5k match and then withdraw excess from my old employer
2. I should contribute the entire 20,500 to the new plan (thus over contributing on purpose) to get the $10.5k and then do nothing (i.e. pay taxes on excess twice in order to keep the old employer's match)
3. I should only contribute 9k to the new employer's plan in order to avoid exceeding the 20.5k limit across both plans. I will only be able to collect 4.5k (leaving 6k in match dollars on the table)
1. Your old employer is under no obligation to help you by withdrawing the excess (regardless of what Fidelity says about the process) since it's not an excess deferral in their plan. A qualified plan can get in significant trouble if it allows a participant to exceed the deferral cap and doesn't correct it, but that refers to exceeding the cap within that plan, not in aggregate across multiple unaffiliated plans.

2. This would be my choice but you'd need to evaluate the pros and cons between 2 and 3. Maxing out deferral at employer B would mean $11,500 in non-deductible deferrals that would be taxed as regular income when withdrawn. In exchange, you would receive $6,000 in matching contributions. An oversimplified comparison would be: is the tax on the $11,500 non-deductible deferrals more or less than $6,000?

If you're in the 22% marginal bracket for example, you'd pay $2,530 in taxes on $11,500 in income. That's less then the $6,000 match, so it's worth it to exceed the cap.
I'm at a higher marginal bracket but still worth paying the taxes to get the 6k. So between 2 and 3, I think 2 is better.

If 1 were to be allowed (old employer agrees to withdraw the excess), should I withdraw the excess or should I think of the 11.5k as a brokerage account investment that doesn't come with any tax benefits anyway (am I missing any additional nuance?) and choose to do 2? I would lose my first employer's match of $2.2k if I do 1 and I'm not sure how the excess contribution would affect me since I'm currently at a loss on those contributions.

For 2, what should I look out for on my taxes? Will standard tax software be able to handle this or should I get someone to prepare my taxes? Is there a penalty for excess contribution or just the taxes that I would anyway pay on brokerage account contributions?
secondcor521
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by secondcor521 »

The IRS website says that you can do an excess deferral corrective distribution any time before April 15th of the next year. But one article I read said that the 401(k) plan administrator might have an earlier deadline for you to submit the request so they have time to actually make the distribution before the deadline.

I would contact my old employer's HR department and ask for the 401(k) plan document, and then read it to see if it addresses this situation. I would hope that your old 401(k) plan would permit an excess deferral distribution.

I'd also try to figure out when the matching happens. I strongly suspect that your first employer would *not* claw back any match already made.

Based on the results of the above two items, I would likely try to implement your option 1, doing the excess deferral corrective distribution early in 2023 and hopefully retaining all of the match from both employers.

(There is also an employer-employee total contribution limit, but it looks like you would be far below that amount.)

A 50% match would be $10,250, not $10,500. Probably doesn't affect your math or decision making, but it might.
TropikThunder
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by TropikThunder »

sheelu0125 wrote: Fri Oct 07, 2022 8:31 am For 2, what should I look out for on my taxes? Will standard tax software be able to handle this or should I get someone to prepare my taxes? Is there a penalty for excess contribution or just the taxes that I would anyway pay on brokerage account contributions?
Not sure about how a match would be handled if you remove the excess from employer A, but yes any tax software will detect the overage and add it back to your wages.
Topic Author
sheelu0125
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by sheelu0125 »

secondcor521 wrote: Fri Oct 07, 2022 11:27 am The IRS website says that you can do an excess deferral corrective distribution any time before April 15th of the next year. But one article I read said that the 401(k) plan administrator might have an earlier deadline for you to submit the request so they have time to actually make the distribution before the deadline.

I would contact my old employer's HR department and ask for the 401(k) plan document, and then read it to see if it addresses this situation. I would hope that your old 401(k) plan would permit an excess deferral distribution.

I'd also try to figure out when the matching happens. I strongly suspect that your first employer would *not* claw back any match already made.

Based on the results of the above two items, I would likely try to implement your option 1, doing the excess deferral corrective distribution early in 2023 and hopefully retaining all of the match from both employers.

(There is also an employer-employee total contribution limit, but it looks like you would be far below that amount.)

A 50% match would be $10,250, not $10,500. Probably doesn't affect your math or decision making, but it might.
Good point on the employee employer total contribution limit. Both my previous and current employer allow after tax contributions (megabackdoor roth), so I was planning to max out that too. If I decide to max out contributions to new employer and not remove excess from old employer (option 2), would the excess count towards the overall employer employee limit? Or only the 20,500+employer matches + after tax count towards the cap?
secondcor521
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by secondcor521 »

sheelu0125 wrote: Fri Oct 07, 2022 11:09 pm If I decide to max out contributions to new employer and not remove excess from old employer (option 2), would the excess count towards the overall employer employee limit? Or only the 20,500+employer matches + after tax count towards the cap?
I'm not sure, but I think it's it all employer and all employee contributions regardless of before/after tax, so I would guess it would count. Perhaps someone else knows better than I do.
lakpr
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Re: Excess contribution to 401K on purpose (is it worth it?)

Post by lakpr »

There is only the $20,500 employee contribution limit across the employers. The limit of $61,000 across employee contributions + employer match + post-tax contributions by employee are PER EMPLOYER.

So you can have:
Employer A: $20,500 (employee contribution) + $7,000 (employer match) + $27,000 (hypothetical post-tax amount)
Employer B: $20,500 (intentionally exceeding employee limit) +$9,000 (employer match) + $27,000 (hypothetical post-tax amount)
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