Pushing the limits on your retirement savings isn't a bad problem to have.
It can cost you.
So, it's best to save right up to your eligible maximum.
With 401k(s) and IRAs, the contribution limits can vary as you earn more income. That's why it can be difficult to max out your retirement savings exactly.
If you happen to overcontribute to a 401(k) or IRA, learn what you can do to avoid extra penalties and taxes.
How You May Have Contributed More Than the Limit
There are a number of ways that you could wind up overcontributing to a 401(k) or IRA.
You may have received a raise at work, which increased the automatic 401(k) contribution you make each paycheck to an amount that exceeds the limit.
Or, your raise might put you over the income limit to be eligible for an IRA.
You could also simply make a bookkeeping mistake and accidentally contribute more than you intended to.
Regardless of the reason you overcontributed, you should take steps to fix the mistake.
401(k)s are employer-based retirement accounts. They are provided by employers as a benefit for employees.
You can contribute money to the account directly from your paycheck and many employers will also contribute money on your behalf.
Rules and limits
All 401(k)s place a limit on your annual contributions, but the exact limit can vary based on a number of factors.
One (almost) universal is that no one can contribute more than $18,500 to a 401(k) in a single year ($19,000 starting in 2019).
The only exception is for those who are 50 or older, who may make an additional $6,000 in contributions for a total of $25,000. If you have multiple 401(k)s, this limit is shared across all 401(k) accounts.
If you make less than $18,500 a year, you can only contribute as much as you make. If you make only $15,000 a year, possibly because your job is part-time, you are limited to contributing $15,000.
If you are a highly compensated employee, defined as receiving at least $120,000 in compensation from the employer providing your 401(k), your contributions may be limited based on how much other people at your company contribute.
This rule was put in place by the IRS to help prevent companies from providing retirement plans designed only for people who make a lot of money.
If you overcontribute to your 401(k), the key date to keep in mind is April 15th.
This date is easy to recall because it is the due date for annual tax returns.
The key point:
You have until April 15th of the next year to withdraw any overcontribution and its earnings.
If you do not resolve the problem by April 15th, you may keep the money in your 401(k), but you’ll pay income taxes as normal.
You’ll then pay income taxes on it again when you withdraw the money.
Effectively, the excess contributions will be taxed twice.
How to fix an overcontribution
The good news
When it comes to fixing 401(k) overcontributions, your plan administrator is there to help.
You can contact your plan administrator and ask them to remove any overcontributed amount (also known as an excess deferral) from the account and to send you a check for the balance.
Your company should be able to point you toward the right person to contact to get help.
Many 401(k) plans move slow, so it’s in your best interest to get the process started as soon as possible to avoid running over the April 15th deadline.
One thing to keep in mind is that any money that your employer deposits on your behalf does not count towards your contribution limit.
For example, if your employer contributed $1,500 to your retirement plan in 2018, you can still contribute the full $18,500, even though $20,000 is the actual amount that has been deposited to your 401(k).
Individual retirement accounts (or IRAs) are retirement accounts that anyone can open.
They’re not tied to your employer and operate independently from any employer-based retirement plan you may be eligible for.
Rules and limits
IRAs function very similarly to 401(k)s in that there is a limit to how much you can contribute to an IRA each year.
You are limited to contributing $5,500 to an IRA each year ($6,000 starting in 2019). People who are 50 or older can contribute an additional $1,000 each year.
One thing that differs between 401(k)s and IRAs:
There is a strict income limit on contributions.
Single people can only get the tax benefits of a traditional IRA if their Modified Annual Gross Income (MAGI) is less than $120,000.
Once your MAGI exceeds $120,000 you’ll receive tax benefits on only a portion of the maximum contribution. At a MAGI of $135,000 or greater, you’ll receive no tax benefits.
One benefit of IRAs is that they are more flexible than 401(k)s when it comes to contribution timing.
Where you can only contribute to a 401(k) through a payroll deduction, you can make a deposit to an IRA anytime.
You can make contributions to an IRA up to April 15th of the following year, giving you a bit more than 15 months to put money in the account.
How to fix an overcontribution
IRAs are also more flexible when it comes to fixing errors.
If you notice that you overcontributed to your IRA after you file your tax return, you can fix it in one of two ways.
- Remove the excess contribution and any earnings and file an amended return by October 15th.
- Reduce your contributions for the next year by the amount you overcontributed.
So, if you contributed $7,000 even though your contribution limit is $6,000, you should only contribute $5,000 or less in the next year.
The bad part:
You’ll pay a penalty of 6% of the overcontributed amount but won’t have to deal with as much paperwork.
If you don’t fix your error, you’ll pay a penalty of 6% of the overcontributed amount each year, so make sure you fix your mistake as quickly as possible.
Early Withdrawal Penalties
One thing to keep in mind with 401(k)s and IRAs is that the money you contribute to these accounts is intended to be used in retirement.
The government provides tax benefits to encourage people to save for the future, so there are penalties if you make a withdrawal before you reach retirement age.
You can make withdrawals from both 401(k)s and IRAs penalty-free once you turn 59½.
Any withdrawal before that age will be subject to a 10% penalty.
This penalty is in addition to the income tax that you’ll owe on the withdrawn amount.
There are some exceptions to this rule.
You can make an early withdrawal if you meet any of the following requirements:
- You pass away and the account is given to your beneficiary
- You become disabled
- You are at least 55 years old and leave your job (401(k) only)
- You withdraw less than the allowed amount of a valid medical expense
- You invoke rule 72(t) to get regular payouts from the account
While you can max out your retirement account each year if you want to, remember that the money you contribute is stuck in the account for the long term.
If you need access to some of that money in the short-term, consider keeping an amount outside your IRA or 401(k).
Save For Retirement in Addition to an IRA or 401(k)
Saving for retirement is an important part of ensuring you have a healthy financial life.
Many workers today lack pensions and Social Security payments often don’t provide enough to live on.
Ensuring that you have a nest egg to support you after you finish working can provide a lot of peace of mind.
If you’ve maxed out your retirement accounts, you don’t have to stop saving for retirement.
There are a few other accounts that you can use to save.
Taxable brokerage accounts
Taxable brokerage accounts are one of the easiest ways to save once you’ve maxed out your retirement accounts.
You can also use them to save for non-retirement goals.
These accounts let you invest your money in stocks, bonds, and mutual funds, but you can withdraw the money at any time without any tax penalties.
If your investments gain value, you will be responsible for capital gains tax.
Health savings Accounts
Health savings accounts (HSAs) are designed to help people with high deductible health plans (HDHPs) set aside money for medical emergencies.
If you have an HDHP, you can contribute $1,350 each year ($2,700 for family plans).
If you use the money for medical expenses, you pay no tax when you deposit the money and when you withdraw it.
If you turn 65 and still have money in the account, you can withdraw money from your HAS as though it were an IRA or 401(k).
You’ll pay taxes on the withdrawals but have saved on taxes when you made the contributions.
In this way, an HSA can act as an additional retirement account, so long as you don’t need to use it to pay for medical care.
Overcontributing to a 401(k) or IRA isn’t the worst problem to have.
It means that you’re doing a great job of saving money for retirement.
If you do wind up overcontributing, make sure to correct the problem as soon as you are able.