Ultimately, it’s your job to make sure you don’t over-contribute.
Laura answers a listener’s question about contributing too much to a 401(k) and reviews contribution limits for various accounts, how to correct overpayments, and avoid penalties.
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Kat from Atlanta says, “Thank you for all your work–I feel so much smarter because of you. I’m a pretty well-compensated employee and was fully vested from day one at my job (how often does that happen?). I’m contributing 8% to my traditional 401(k) and getting a company match. I also contribute 8% to my Roth option.
Since we’re almost halfway through the year and I’ve contributed about $13,000, I’m on track to exceed my annual contribution limit of $22,500, and I don't want to get dinged for an overpayment. My question is whether the annual limit includes Roth and traditional 401(k) contributions? Thank you for your feedback–I’m a super fan of the podcast as all my friends know!”
Kat, thanks so much for your question and for being a superfan! Also, congratulations on maxing out your retirement plan. Being at risk of over-contributing is a wonderful problem to have!
While over-contributing to tax-advantaged accounts, such as workplace retirement plans, individual retirement accounts (IRAs), and health savings accounts (HSAs), isn’t allowed, it can be easy to do by mistake. This episode will answer Kat’s question, review contribution limits for various accounts, and explain how to correct overpayments and avoid penalties.
Hey, everyone, and welcome back to Money Girl—I'm really glad you're spending some time with me! If you're a new listener, my name is Laura Adams. I'm an award-winning author and finance expert who's been bringing money tips and advice weekly on this podcast since 2008, with over 40 million downloads.
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What happens if you over-contribute to a workplace retirement plan?
If you’re like Kat and are fortunate enough to have a workplace retirement plan, like a 401(k) or 403(b), it’s an incredibly valuable benefit that you shouldn’t pass up. If your employer matches your contributions, always put in enough to max out free retirement funds.
As Kat mentioned, for 2023, you can contribute up to $22,500, or $30,000 if you're over age 50, to most workplace retirement plans. That amount is the total of your traditional and Roth contributions. For instance, you could split your contribution 50/50 and put $11,250 in your traditional 401(k) and $11,250 in your Roth 401(k), or any proportion you like that adds up to $22,500.
But the good news is that employer contributions don’t count toward the annual limit, allowing you to exceed $22,500. So, if you max out a 401(k) and get a generous 8% match, like Kat, you’d receive an additional $1,800 ($22,500 x 8%), giving you a total contribution of $24,300 ($22,500 + $1,800).
Retirement plan custodians typically have procedures in place to prevent you from contributing too much. In other words, they should notify you when you reach the annual limit so you suspend contributions for the remainder of the year.
However, there are situations when it’s possible to over-contribute, such as having two jobs with retirement plans or switching jobs during the year and enrolling in a new plan. So, ultimately, it’s your job to make sure you don’t over-contribute.
I recommend that Kat, and everyone with retirement plans, put a note on your calendar at the end of every November to double check your contributions. That gives you plenty of time to log on to your online account and adjust or suspend contributions through the end of the year, if needed. The deadline for making workplace retirement contributions for the current year is December 31.
If, at any time during the year, you realize that you’ve over-contributed to a retirement account, contact your plan administrator or custodian right away so they can correct it. If they withdraw the excess contribution by your tax filing deadline (including extensions), you avoid paying a withdrawal penalty.
However, any earnings accrued on the excess contribution while in your account is subject to income tax, plus a 10% early withdrawal penalty if you’re younger than 59.5. So, depending on the timing, your employer may need to amend your W-2 to show the returned earnings as taxable wages.
Note that you can always extend your tax due date to October 15 in any year by filing an extension using Form 4868. That gives you more time to correct overpayments and figure out the resulting taxes.
Remember that if an excess contribution gets corrected quickly there may be no or a small amount of earnings, and therefore no or a tiny tax and penalty. But the longer you allow an excess contribution to sit in your workplace retirement plan, the more it could cost you in taxes and an early withdrawal penalty on its investment growth.
What happens if you over-contribute to an IRA?
If you don’t have a job with a retirement plan or you’re self-employed, anyone with earned income (no matter your age) is eligible for an individual retirement account or IRA. While there’s no income limit to qualify for a traditional IRA, high earners are ineligible for a Roth IRA. Note that other Roth accounts, such as a Roth 401(k) and 403(b), don’t have income limits.
For 2023, the Roth IRA cutoff for singles is when you have a modified adjusted gross income (MAGI) of $153,000 or higher. And married couples filing taxes jointly can't contribute to Roth IRAs when their household MAGI is $228,000 or above.
For 2023, you can contribute as much as your earned income, up to $6,500 to a traditional IRA or a Roth IRA (if you’re eligible). If you’re over 50, you can add an extra $1,000, for a total of $7,500. So, if you’re under 50, you could contribute $3,250 to a traditional IRA and $3,250 to a Roth IRA, or any proportion that adds up to $6,500.
Unlike a workplace retirement plan, you can make IRA contributions up to the tax filing deadline for the previous tax year. For instance, you can make a 2023 IRA contribution as late as April 15, 2024.
Additionally, unlike workplace plans, excess IRA contributions get taxed 6% every year they remain in your account. So, when you realize that you’ve over-contributed to an IRA, it's essential to correct it right away to pay as little tax and penalties as possible.
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Here are three ways to correct an excess IRA contribution:
1. Withdraw the excess before your tax filing deadline.
First, contact your IRA custodian for help withdrawing excess contributions because you must also remove their earnings, which can get tricky to calculate. If you complete the withdrawal before your tax due date, it's like you never put the excess in the account.
However, just like with an excess contribution at work, you owe tax on any earnings the excess accrued while it was in your IRA. Plus, you must pay a 10% penalty on the withdrawn earnings if you're younger than 59.5.
For example, let's say you're 40 and make an excess IRA contribution of $500. If it earned $50 in investment income, you must withdraw $550 before your tax filing deadline to avoid the 6% excess penalty.
The $50 gets added to your gross income for the tax year. And because you're younger than 59.5, you must pay a 10% early withdrawal penalty on your $50 earnings, or $5 ($50 x 10%). Your IRA custodian will send you Form 1099-R showing your taxable earnings so you can submit it with your tax return.
2. Withdraw the excess within six months after you file taxes.
Let’s say you file taxes and then realize you contributed too much to your IRA. In that case, you have six months to correct the error by withdrawing the excess contribution and earnings.
But you must file an amended tax return by October 15 using Form 1040X because you’ll owe taxes plus a 10% early withdrawal penalty (if you’re younger than 59.5) on the excess earnings removed from your IRA.
3. Apply the excess to the following year.
You can ask your IRA custodian to apply excess contributions to the following year; however, the 6% penalty will apply to excess amounts in your account at the end of the year. Therefore, if you can correct an IRA overpayment earlier in the year, you’ll pay much less for the blunder.
What happens if you over-contribute to an HSA?
Another tax-advantaged account that you could over-contribute to is a health savings account or HSA. It’s a medical savings account that allows you to pay for qualifying healthcare costs, such as medical, dental, and vision expenses, on a tax-free basis. To qualify, you must be enrolled in an HSA-qualified high-deductible health plan (HDHP) that you purchase or get through an employer.
Tax-deductible HSA contributions can come from you, someone else, or an employer. Unlike employer matching for a workplace retirement account, employer contributions (or those from anyone else) to your HSA are included in the annual limit. That can make it easy to lose track and over-contribute to an HSA, especially if your employer makes variable contributions on your behalf.
Another situation when you could over-contribute to an HSA is after making a large contribution early in the year but losing your eligible health plan before the end of the year. When you don’t have an HSA-eligible health plan, you're not allowed to make HSA contributions. That means you’d have to remove a proportional amount of excess contributions based on when you lost eligibility during the year.
Note that If you become uninsured or no longer have an HSA-eligible health plan you can still spend your HSA balance but you can’t make new contributions to the account.
Just like with retirement accounts, it’s your responsibility to catch and correct excess HSA contributions. And it’s best to contact your account administrator for help cleaning up the overpayment.
For 2023, if you have an HSA-qualified health plan for yourself, the HSA contribution limit is $3,850. If you have a family health plan, you can contribute up to $7,750. Plus, those over 55 can contribute an additional $1,000.
Like IRAs, you can make HSA contributions up to your tax filing deadline for the previous tax year. So, you can fund an HSA for 2023 as late as April 15, 2024.
Like an IRA, if you over-contribute to an HSA and don't correct it or you choose to apply it to a future year, you must pay a 6% penalty on the excess every year it remains in your account. But if you catch the mistake before you file taxes (including extensions), you can avoid the 6% penalty by withdrawing the excess, plus any investment or interest earnings.
As with retirement accounts, HSA earnings on excess contributions get subject to tax. But if you catch an overpayment right away, the investment gain and tax due will likely be minimal. Your HSA administrator must file Form 1099-SA showing a distribution of excess contributions and correct your Form 5498-SA, which shows annual HSA contributions.
As you can see, even making an honest mistake with a tax-advantaged account can get complicated. So check your contributions toward the end of each year and get help to quickly correct any overpayments.
If you find a problem that you can't fix before the New Year, getting excess contributions corrected in the first quarter of the following year is the next best option. You might have some tax to pay, but the faster your account gets cleaned up, the less expensive your mistake will be.