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

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:

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.

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