correcting an excess deferral

[scardo]

Long time lurker, first post due to a unique tax issue for me.

I am a naval reservist, and I over contributed to my combined civilian 401k and military TSP accounts by $300 in excess of $19500 for the 2020 tax year. I only caught the mistake a few days ago, which puts me past the TSP and 401k plan limits for having this excess deferral refunded back to me. My civilian 401k is administered through Vanguard.

I've been studying the IRS code, and it seems that this excess deferral has to remain in place until I'm eligible to withdraw it, and then it would be taxed on withdrawal. In my case this could be a while since I'm only in my 30s. It also looks like there is an ongoing 6% tax imposed on the excess deferral and any gains for every year that it remains in place.

I would like to do the right thing and fix this. Is it possible to pull the excess $300 out now, take the 10% penalty and be done with it? Or do I have to leave it and track gains until I'm eligible to withdraw it? Would rolling over my 410k to an IRA or Roth IRA be an opportunity to remove the excess amount? Additionally, if the excess deferral remains in place, do I still have to amend my 2020 W-2?

Thank you in advance. Any advice would be much appreciated. 

[secondcor521]

I don't know about the TSP aspect of it, but you should be able to ask the 401(k) custodian to remove the excess $300 plus attributable earnings and return it to you.  They'll calculate the attributable earnings for you, so don't worry about that.  You'll pay the 10% penalty plus ordinary income taxes on the attributable earnings, but those amounts will be small so it's more of a tax filing hassle than anything.

You most emphatically don't need to leave it in.  If you did, you're correct that you would pay the 6% excise tax annually until you removed it.

I haven't looked at it in a while, but I believe the 10% penalty and ordinary income taxes will be on your 2021 return.  You'll get a 1099-R from your 401(k) custodian reporting the withdrawal.

If you left it in, I can't see why you'd need to amend your W-2, assuming it/they were accurate.  In fact you can't "amend" a W-2.  You can only work with your employer to have them issue a corrected W-2 in the rare case something is wrong on it; and an excess deferral isn't technically wrong, it's just something that's penalized in the tax code.  You should just report the actual numbers on your W-2 on your tax return.  If you're using a tax prep product like Turbotax, it would probably notice the excess contribution and point that out to you.

[scardo]

Thank you for the advice. TSP was not willing to pursue a refund, but Vanguard was very helpful when I called them. I have to submit proof of the excess deferral and a letter of instruction to initiate the withdrawal. They confirmed that I'll receive a 1099-R for the 2021 tax year to pay the necessary withdrawal taxes when I file for 2021. The only thing that was unclear is what happens if they manage to issue the refund before April 15th. If this happens, would I be exempt from the 10% penalty tax since the issue was corrected before the IRS deadline?

[secondcor521]

If this happens, would I be exempt from the 10% penalty tax since the issue was corrected before the IRS deadline?

I didn't think so, but it looks like the answer is yes.  See the section "Treatment of excess deferrals" here:

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-401k-and-profit-sharing-plan-contribution-limits

[Nords]

TSP was not willing to pursue a refund, but Vanguard was very helpful when I called them.

You're doing the right thing by going with Vanguard instead of the TSP to fix the excess contribution. 

As far as the TSP is concerned, you don't have an excess contribution on their system so they don't care and they won't help.

The military is aware of this contribution pitfall for Reserve/Guard servicemembers, particularly the National Guard Bureau.  The last few sessions of Congress have introduced legislation to allow Reserve/Guard members to contribute an elective deferral limit to both their 401(k) and TSP accounts (essentially 2x EDLs).  However it's never been passed, and it might never be.

[scardo]

TSP was not willing to pursue a refund, but Vanguard was very helpful when I called them.

As far as the TSP is concerned, you don't have an excess contribution on their system so they don't care and they won't help.

That's exactly what the TSP customer service rep said. Polite, but no willingness to help.

I didn't know about the proposed changes up to Congress. That would be great if passed.