401K contribution question

[mikecweb]

For us I'm planning to use it to cover our medical bills in retirement, that's the plan at least. The company contributes 4k/year and we can do a wellness deal for an extra 600.

 

[woodreau]

Somebody told me I could be taxed twice on the excess and that confused me.

When you defer your salary into your 401k the amount you defer is not taxed (unless it is a Roth 401k deferral)

once you reach your contribution limit any further deferrals (now considered excess deferrals) are also not taxed when they should have been.

The double taxation is if you don’t correct the excess deferral within the same tax year. i.e. calling HR and telling them “hey I’ve reached my contribution limit and now I’m having excess deferrals. So fix it.” The correction needs to occur before the filing deadline of the tax return of the year you have the excess deferral or April 18 2023 for the 2022 tax year.

if it is corrected before the deadline, the excess shows up as normal W-2 wages and normal withholding happens so it’s taxed as normal. All is good. You’re not double taxed.

if you don’t correct it before the deadline you’ll get assessed tax on the excess as it was supposed to be taxed as normal wages anyway.

you finally get around to correcting the issue. But because it’s now after the filing deadline of the tax year you are now in a new tax year, and so when you pull the money out of your 401k to correct the excess deferral, now it’s treated as a distribution from your 401k and you get a 1099-R and 1099-R distributions are considered income and you have to prove why it should not be taxed with an exception. there isn’t an exception for a 1099-R distribution for excess deferrals. So its considered additional income (that you paid taxes on last year) and it gets taxed again at your ordinary income tax rate.

normally if you’re not 59-1/2 when you take a distribution from your 401k there is a 10% penalty assessed for the early distribution. But there is an exception for excess deferral/contribution distributions so thankfully you get to keep the 10% penalty.

that is the double taxation part of it.

sorry for the complicated explanation. you can blame congress…. all of the rules on taxation and tax deferral and tax advantaged accounts are created by Congress.

so when Congress decides that they want to do away with the IRS and replace it with a national sales tax. Everything about 401k retirement accounts, individual IRA, Roth IRAs and SIMPLEs, Health Savings Accounts, 529s and educational savings accounts and ABLE accounts - All of that goes away…. And it’s going to be a big mess how they’re going to treat all of these formerly tax advantaged accounts that all of us have.

since you’re turning 50 you’ll be able to defer $22,500 of your salary into your 401k in 2023 plus the $7,500 catch-up contribution. The $7,500 catch up doesn’t count against the 2023 $63,000 limit for 401k contributions. so your company contributes their $40,500 you contribute your $22,500 plus your $7,500 catch up for a $70,500 contribution into your 401k for 2023 because you’re 50 or older.

 

[ZapBrannigan]

Woodreau thank you! That’s really helpful. So basically I need to watch my pay stubs, and when I hit the $30,000 limit call payroll and make sure they’re taxing me on future contributions?

 

[arkflyr]

There are two articles on this in the last couple months of the RP from Drew and Brian. The first is about how to avoid being crowded out by the NEC contribution if you are looking to max out your personal contribution and the other one has some good stuff on traditional vs Roth contributions.

I'm also pretty sure that once you hit your contribution limit payroll just cuts you off from putting anymore into your 401K, unless you have opted into one of the excess benefit plans. I am not 100% sure on how all of those work.

 

[woodreau]

Woodreau thank you! That’s really helpful. So basically I need to watch my pay stubs, and when I hit the $30,000 limit call payroll and make sure they’re taxing me on future contributions?

no you shouldn’t need to.

As you discovered payroll automatically stopped deferring your salary when you reached your $ 20,500 personal contribution limit last year.

they know you’re 50 and they’ll keep going when you reach $22,500 in 2023. And then stop deferring after you reach $30k.

it’s (should be) automatic.

At my shop once I reach the $63,000 limit (the 22.5k personal limit plus the company direct contribution) my company stops contributing to the 401k. But it still tracks the amount of the 15% contribution it should have made. The following year the company just pays lump sum all of the money it should have contributed into my 401k but couldn’t. Other companies like Delta throws it into another part of their retirement plan and allow you to mega-back door into a Roth part of the retirement plan. And sounds like United puts the excesss into a medical reimbursement account. So what Southwest does you’ll have to check.

for me at my shop, I get an extra paycheck the following year in Feb or Mar.


usually the problem of excess deferrals is when you have two employers and two 401ks each employer only tracks what they’ve taken out of your salary. The limit is an individual limit…

so a pilot under 50 who maxed out their $22,500 personal contribution by October at their regional and gets hired with another airline moving out of the regionals to a major airline like Delta. the major airline starts making contributions to the pilots 401k there. That will be a problem for that pilot. Neither airline knows that the pilot has over contributed. It’s up to the pilot to know, track it and fix it before the due date of the tax return.

Anyways. It not really a problem that first officers encounter. It’s really a captain problem .