(b)lines Ask the Experts – Discovering an Excess Deferral in the Year of the Excess

“The deferrals have already been deposited into her account with the recordkeeper. Since 2016 has not ended as yet, can I simply request the money back from the recordkeeper and arrange for our payroll department to fix her W-2 so that the proper deferral amount is shown?” 

David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer: 

Thank you for your question, as it addresses a common misconception among plan sponsors concerning what happens if one discovers an excess deferral in the year of the excess (for example, if a 2016 excess deferral is discovered in 2016).

But before we get to that, the Experts would suggest that you confirm the individual is not eligible for elections that may allow her to exceed the 402(g) limit, such as the age-50 catch-up election or the 15-year catch-up election for 403(b) plans, if permitted under the plan document. For example, if your CEO is age 50 or older as of 12/31/2016, she may defer up to $24,000 in 2016, as opposed to the standard 402(g) limit of $18,000. The 15-year catch-up is much more complicated than the age-50 catch-up election, but, if your CEO qualifies for that election, up to an additional $3,000 may be deferred over and above the 402(g) limit. Thus, if she only qualified for the 15-year catch-up, and not the age-50 catch-up, she may be able to defer up to $21,000 in 2016. However, if she qualifies for BOTH catch-up elections, it may be possible for your CEO to defer up to $27,000 in 2016.

If your CEO still has an excess after reviewing the catch-up options that might be available to her, there is indeed an excess deferral that should be corrected. Though the procedure for correction of the excess is slightly different than when an excess is discovered after the close of the year, the procedure does not permit the plan sponsor to request the money back from the vendor and correct the W-2 as you describe, so plan sponsors should NOT take such an action. According to Treas. Reg. 1.402(g)-1(e)(3), a distribution of the excess deferral shall be made by the plan to the participant, and such distribution must satisfy the following conditions:

(A) The individual designates the distribution as an excess deferral. If any designated Roth contributions were made to a plan, the notification must identify the extent to which, if any, the excess deferrals are comprised of designated Roth contributions. A plan may provide that an individual is deemed to have notified the plan of excess deferrals (including the portion of excess deferrals that are comprised of designated Roth contributions) for the taxable year calculated by taking into account only elective deferrals under the plan and other plans of the same employer and the plan may provide the extent to which such excess deferrals are comprised of designated Roth contributions. A plan may instead provide that the employer may make the designation on behalf of the individual under these circumstances.

(B) The correcting distribution is made after the date on which the plan received the excess deferral.

(C) The plan designates the distribution as a distribution of excess deferrals.

Since the excess is distributed in the same year of the deferral of such excess, the excess, as well as income related to the excess, are both taxed in 2016. The plan recordkeeper will provide the participant with the appropriate tax forms so that the participant can declare this distribution of excess (and related earnings) as taxable income in 2016. The W-2 shall NOT be adjusted, and would reflect the total deferral, including the excess deferral amount. Note that this taxation differs from an excess deferral in 2016 that is distributed in 2017, as the income related to the excess would be taxed in 2017, the year of the distribution, and not in 2016.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.