One of the accountants had a question for me:
A: I added up the W-2s, but the wages
per the software does not agree to my number.
CTG: Is
your number lower?
A: Yes.
Let’s talk about 401(k)s. More specifically, let’s
talk about 401(k)s when one changes jobs during the year. It can be an issue if
one is making decent bank.
You are under age 50. How much can you defer in a
401(k)?
For 2021 you can defer $19,500. The limit increased to
$20,500 for 2022.
You change jobs during 2021. Say you contributed
$14,000 at your first job. The second job doesn’t know how much you contributed
at first job. You contribute $12,000 at your second job.
Is there a tax problem?
First, congrats. You are making good money or are a
serious saver. It could be both, I suppose.
But, yes, there is a tax problem.
The universe of retirement plans is divided into two
broad categories:
· Defined
benefit
· Defined
contribution
Defined benefit are also known as pension plans.
Realistically, these plans are becoming extinct outside of a union setting,
with the government counting as union.
Defined contribution plans are more commonly
represented by 401(k)s, 403(b)s, SIMPLES and so forth. Their common feature is
that some – maybe most – of the dollars involved are the employee’s own dollars.
Being tax creatures, you know that both categories
have limits. The defined benefit will have a benefit limit (the math can be
crazy). The defined contribution will have a contribution limit.
And that contribution limit is $19,500 in 2021 for
someone under age 50.
COMMENT: If you google “defined contribution 2021” and come back with $58,000, you may wonder about the difference between the two numbers. The $58,000 includes the employer contribution. Our $19,500 is just the employee contribution. This difference is one of the reasons that solo 401(k)s work as well as they do: they max-out the employer contribution – assuming that the income is there to power the thing, of course.
Let’s go back to our example. You deferred $26,000 for
2021.
Are you over the limit?
Yep.
If you add your two W-2s together, is the sum your
correct taxable wages for 2021?
Nope.
Why not?
Because a 401(k) contribution lowers your (income) taxable
wages. You went $6,500 over the limit. Your taxable wages are $6,500 lower than
they should be.
What do you do?
There are two general courses of action:
(1) Contact one of the employers (probably the second one) explain the issue and request that the W-2 be amended by the deadline date for filing your return – that is, April 15. Rest assured, you have just drawn the wrath of someone in the accounting or payroll department, but you have only so many options.
BTW the earnings on the excess contributions are also taxable to you. Say that you earned 1% on the excess. That $65 will be taxable to you, but it will be taxable the following year.
In
summary,
§ Your
2021 W-2 income goes up by $6,500
§ You
will report the $65 earnings on the excess contribution in 2022.
It is a mess, but
the second option is worse.
(2) You do not contact one of the employers, or
you contact them too late for them to react by April 15.
Your 2021 W-2s
show excessive 401(k) deferral.
Your tax preparer
will probably catch this and increase your taxable W-2 totals by $6,500. This
is what created the accountant’s question at the beginning of this post.
Oh well, you say.
You are back to the same place as option one. No harm, no foul – right?
Not quite.
First, your employer may not be too happy if the issue is later discovered. This is an operational plan issue, and there can be penalties for operational plan issues.
Second, once you go past the time allowed for correction, the money is stuck in the plan until you are allowed take a distribution (or until the employer learns of the issue and corrects the plan on its own power).
Say you never tell them. Let’s not burn this bridge, right?
Problem. Take a look at this bad boy:
Section
402(g)(6) Coordination with section 72 .
For purposes of applying section 72 ,
any amount includible in gross income for any taxable year under this subsection but
which is not distributed from the plan during such taxable year shall not be
treated as investment in the contract.
What does this assemblage of mostly unintelligible words mean?
It means that you will be taxed again when the 401(k) finally distributes the excess contribution to you.
Yep, you will be taxed twice on the same income.
That $6,500 got expensive.
Upon reflection, there really is no option
2. You have to tell your employer and have them correct the W-2.
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