Ask the Experts February 27, 2024

How Can a 402(g) Excess Deferral Be Corrected?

Experts from Groom Law Group and CAPTRUST answer questions concerning retirement plan administration and regulations.

Reported by

Q: I want to properly correct 2023 402(g) excess deferrals made to our 403(b) plan, but it appears that the Experts have not written on that subject in a couple of years. Can you provide updated information?

Kimberly Boberg, Taylor Costanzo, Kelly Geloneck and David Levine, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

Never miss a story — sign up for PLANSPONSOR newsletters to keep up on the latest retirement plan benefits news.

A: Absolutely! For those who might not be aware of a 402(g) excess deferral, it occurs when a participant’s total elective deferrals exceed the annual limit for retirement plans in a calendar year. For 2023, that limit was $22,500 ($30,000 if the participant was age 50 or older as of December 31, 2023). (There are some additional expansions of the limit for certain 403(b) and 457(b) plan participants, but these are the limits for most participants.) For example, if a 51-year-old participant deferred $34,000 in 2023, the participant would have an excess deferral of $4,000 ($34,000-$30,000).

The first step to correcting a 402(g) excess deferral is notifying the plan’s recordkeeper of the amount of the excess deferral. The recordkeeper will then calculate the earnings attributable to the excess and issue a distribution to the participant in the amount of the excess, plus earnings (or less losses, if any). For 2023, since the recordkeeper must distribute the excess deferral (and any earnings accrued) no later than April 15, 2024 (i.e., the individual’s tax deadline in the year following the year of deferral), you should notify the recordkeeper immediately of the excess deferral. It is important that NO adjustments be made to the participant’s 2023 Form W-2 (i.e., the entire amount of the deferral, including the excess, should be reflected in Box 12 of the W-2).

You should also inform the participant immediately of the excess deferral amount, as the participant will need to add the amount of the excess deferral to their 2023 Form 1040 or 1040-SR tax return. Similar rules apply to the participant’s state income tax filing, except for states that do not recognize an income tax exclusion for deferrals in the first place (e.g., New Jersey, where ALL 403(b) deferrals—but not 401(k) deferrals—are taxable as income).

The income attributable to the excess deferral will be taxable in the year of distribution (2024 in this case). (If a loss—rather than income—is attributed to the excess deferral, it is also reported on the participant’s Form 1040/1040-SR for 2024, but there is a special reporting procedure.) You should note that if the distribution occurs after April 15, 2024, the excess deferral is taxable in the year of the deferral and the year distributed. The earnings are taxable only in the year distributed. As such, it is important to make timely distributions.

As for the official reporting of the transaction to the IRS, the plan must report corrective distributions of excess deferrals (including earnings) on Form 1099-R. For excess deferrals and earnings distributed between January 1 and April 15, 2024, the recordkeeper will generally issue two 1099-R reporting forms in early 2025: one for the principal amount of the excess deferral (already declared by the participant as income in 2023) and one for the earnings attributable to the excess deferral (which the participant would report as income on their 2024 Form 1040/1040-SR tax return). However, if a loss is incurred on the excess deferral, only one Form 1099-R will be issued. 1099-Rs are for IRS reporting purposes only and are NOT attached to tax returns. Notably, the excess deferrals and income are not eligible for rollover.

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.

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Amy.Resnick@issgovernance.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future column.

Products February 27, 2024

New Income Planning Tool to Advise Retirees on How Much to Withdraw

Michael Finke and Tamiko Toland announced the launch of IncomePath—a tool to help retirees visualize what they can spend in retirement, while factoring in investment risk, annuity options and life expectancy.

Reported by

To help retirees better understand how much they can safely spend, while taking into account unpredictable factors like investment risk and an unknown lifespan, retirement industry veterans Michael Finke and Tamiko Toland have announced the launch of IncomePath—a retirement-income planning tool. 

In their new white paper, “Freedom to Spend: Building a Better Retirement Income Plan Using Income Paths and Flexible Spending,” Finke and Toland argue that an adaptive withdrawal strategy can allow retirees to take larger withdrawals early in retirement. The trade-off is that retirees would have to commit to more modest spending increases later in retirement. 

For more stories like this, sign up for the PLANSPONSOR NEWSDash daily newsletter.

While IncomePath will initially only be available to individual financial professionals in the retail environment, Toland says she sees an opportunity for creating customized versions of the tool for different firms and different products in the 401(k) sector. Toland says she is having conversations with 401(k) providers to figure out how the tool can be used as part of the “participant experience.” 

The tool, expected to be available for individual financial professionals in the coming months, includes a “step-by-step” retirement income planning guide and visual aid that allows retail clients to choose their lifestyle path, according to Toland and Finke.  

IncomePath allows a financial adviser to select the right combination of investment risk, portfolio withdrawals and annuity income to help visualize how risk affects possible lifestyle paths and spending in retirement. Toland says the tool is meant to be used alongside other retirement planning software that already exists. 

“One of the things that we want people to really understand is that when you have guaranteed income from an annuity, that allows you to investment more aggressively into equities with the rest of your portfolio,” Toland says. “Because you don’t have to take withdrawals as much out of the rest of the portfolio, then you can allow it to grow and it can work in your favor, giving you more of a potential of increasing income during retirement.” 

Since leaving TIAA in September 2023, where she was the head of lifetime income strategy and market intelligence, Toland started her own consulting firm—Toland Consulting LLC— and is now the CEO of IncomePath. Toland has focused on the issue of lifetime income since she was a trade journalist covering annuities more than 20 years ago.  

Finke is IncomePath’s chief strategist and is also a professor and chair of economic security at the online American College of Financial Services.  

In the defined contribution system, Finke says investors have a greater responsibility for figuring out how to turn their savings into income. He says planning software often focuses on the “lens of failure.” For example, a planning tool may tell a person to take out a certain amount of money every year with a “15% chance of failure.” 

“In many ways, [that’s] really the wrong way to think about it, because it assumes that you’re going to spend the exact same amount of money every year, which is not realistic,” Finke says. “[If] the markets don’t do well, you’re probably going to adjust downward a little bit. So [the failure model] doesn’t allow for spending flexibility, and it also focuses on something that’s very negative.” 

In building IncomePath, Finke says he and Toland wanted to create a process that is “realistic and optimistic” and helps people understand the relationship between investment risk and spending. They also intended to demonstrate how taking a portion of one’s savings and using it to buy an annuity can impact the path of spending over time.  

The methodology behind IncomePath involves a withdrawal strategy that recalculates every year based on the account value and expected lifespan of the individuals. In addition, it allows a withdrawal adjustment that permits spending flexibility up to a stated percentage of the previous year’s withdrawal.  

Finke and Toland argue that the 4% rule—withdrawing up to 4% of one’s savings in the first year of retirement—provides a “reasonable” degree of income flexibility that many retirees would tolerate. However, unlike the 4% rule, the experts believe that spending more when asset returns are higher allows a retiree to enjoy a lifestyle benefit from accepting investment risk.  

“We have a really flexible approach to actually implementing this,” Toland says. “Right now, we don’t really see going directly to consumers as a great way of helping them have a more confident retirement because most people need some kind of guidance. There are lots of financial planning tools out there for financial professionals, and they’re great. They’re often very detailed and include things like taxes and specific asset allocations. What we’re really focusing on is a different way of showing … retirement outcomes that [are] much more high level and directional, and then also integrat[ing] that annuity piece.” 

«