402g Limit on Employee Deferrals
The 402g limit is one of the most commonly known 401k contribution limits for qualified retirement plans (though it’s probably not commonly known as the 402g limit).
Section 402(g) of the Internal Revenue Code limits an employee’s elective deferrals into a 401k or 403b plan to $17,000 in 2012. Because section 402(g) in the Code is where these rules reside, the limit is simply called the 402g limit.
During annual non-discrimination testing, anyone who contributed more than this maximum limit is identified and corrected. The correction must occur by April 15th of the following year or you face paying a penalty to the IRS for over-contributing. If you think this may be you, always make sure you are getting your refund timely!
To correct, your 401k provider will simply send the amount you over contributed back to you, along with any earnings that money has made while in the plan. Any employer matching contributions you may have received as a result of the over contribution will also be forfeited from your account and returned to the employer (remember, this was not rightfully your money to begin with, so don’t be too upset when you don’t get it back!)
The money that is returned to you will become taxable income in the year in which you received it, not necessarily the year it was contributed to the plan. So be prepared for that.
Note: Catch-up contributions do not count towards the 402g limit (or any other limit for that matter).
What if I contributed to more than one 401k or 403b during the year?
The 402(g) limit of $17,000 in 2012 applies to any and all 401k’s or 403b’s you may have contributed to throughout the year. It’s not $17,000 for each plan, it’s $17,000 total.
As a result, it is possible you may have deposited more than the 401k contribution limits allow. If this is the case, this will not be caught during testing. The responsibility to ensure you did not over contribute to your 401k in this case falls on you. We frequently see individuals who have made this mistake.
If you realize, at any point, that you did over contribute to your plans, step one is to notify your current employer immediately. They need to know when this happens. Step two is that it needs to be corrected. You will need to find out from your current employer or 401k provider the proper steps to correct, but it’s generally the same across most plans.
You will need to send a copy of your W-2 from your previous employer along with a letter to your current 401k provider asking them to remove the excess amount from your account. The reason you send your W-2 from your previous employer is because it contains all the information about how much you deferred into that company’s retirement plan while you were there. This is something your current provider won’t have (unless the provider was the same for both employers-in this case you would still probably need to send a letter requesting the excess be returned to you).
From there, the method of correction on these 401k contribution limits are the same as described previously. You will receive the entire amount you over contributed along with any earnings that money has made. You will owe taxes as ordinary income on the amount refunded back to you in the year in which you receive it.
I didn’t exceed the contribution limit this year, but I still got a refund. Why?
Just because the IRS allows you to contribute the 401k limit of $17,000 in 2012 doesn’t necessarily mean you can contribute that much. There are other factors that may limit the amount of money you can put into your account.
One possibility may be the limit your employer has placed on what percentage of your salary you contribute. Let’s say for example you make $100,000 a year, but your employer limits the contributions to your 401k to 10%. That means you can only contribute $10,000. If you happened to exceed this $10,000 somehow, you will get a refund for the difference.
Another possibility for a refund could be because you are a highly compensated employee (HCE) and you contributed too much in relation to the non-highly compensated employees (NHCE) in the plan.
Whether or not a HCE contributes too much in relation to NHCE’s is determined during the annual non-discrimination tests. The test that determines which HCE’s contributed too much is called the ADP test. ADP stands for Actual Deferral Percentage.
In this case, the ADP of all highly compensated employees cannot exceed two percentage points higher than the ADP of all non-highly compensated employees.
For example, let’s say you are a HCE earning $110,000 and you contributed 12% of your salary throughout the year. That means you would have contributed $13,200 (certainly less than the $15,500 maximum).
Let’s also say that the ADP for NHCE’s is determined to be 6%. If the ADP for the HCE group cannot exceed the ADP for the NHCE group by more than 2%, that means the HCE group needs to have an ADP of no more than 8%. If it does, you’re in the clear and you don’t need a refund of any kind. If the ADP for the HCE group does exceed 8%, then you will need a refund because you contributed 12%.
The amount you get back may be determined by several factors, so we won’t go into any more detail than necessary. We simply want you to understand that just because you didn’t go over the limit for the year doesn’t mean you won’t get money sent back to you.
From this example here, it’s easy to see why your employer probably encourages participation so much in the plan. They want everyone to contribute as much as possible. If the NHCE’s contribute substantially less, then that limits how much everyone else in the plan can contribute.