Internal Revenue Code Section 415(c) limits the total amount that can be contributed to employer-provided qualified benefit plans – whether it comes from the employee, the employer, or both.
During a “limitation year,” which is generally the calendar year unless another 12-month period is specified in the benefit plan, the total of annual additions allocated to each participant’s account – including employee deferral contributions, employer matching contributions, employer discretionary profit-sharing contributions, and forfeitures allocated – cannot exceed the lesser of $40,000 (adjusted for inflation) or 100% of the participant’s compensation. For 2016, the limit is $53,000 (unchanged from 2015).
For 401(k) plans, the types of contributions subject to the limit include:
- Elective contributions (pre-tax or Roth)
- After-tax employee contributions
- Employer matching contributions
- Employer profit-sharing contributions
To ensure that your employee benefit plan does not violate IRS standards, plan administrators should regularly assess the amount that is being contributed by employees and matched by employers (along with any discretionary profit-sharing contributions, forfeiture allocations, and other elective contributions) to guarantee that planned allocations are within maximum limits. However, if you failed to catch contributions that have already gone overboard and know you’ve exceeded Section 415(c) limits, follow the guidance provided by the IRS below to remedy the error.
Fixing Contribution Limit Mistakes
If qualified plan contributions include both employer and employee elective contributions, then correction for contributions that exceed the participant’s limitation under Section 415 should be made. Follow the guidance below in the order specified until the excess contribution has been accounted for:
Step 1: Distribute unmatched elective contributions made by the employee (adjusted for earnings) to the affected participant. If any excess remains, then proceed to step 2.
Step 2: Distribute elective contributions (adjusted for earnings) made by the employee that are employer-matched and forfeit related matching contributions (adjusted for earnings). If any excess remains, proceed to step 3.
Step 3: Forfeit other profit-sharing contributions.
If an employee made $150,000 in 2015, the 415 (c) limit is $53,000 (the lesser of $53,000 or their total compensation). Assume the following contributions were made on the participant’s behalf to their 401(k) for 2015:
- Elective contributions: $20,000
- Employer matching contributions: $9,000 (100% match up to 6%)
- Employer profit-sharing contributions: $40,000
In this case, total contributions are $69,000 – exceeding the limit by $16,000. To correct this, you would first distribute the $11,000 in unmatched elective contributions (step 1), which leaves $5,000 remaining. The employee made $9,000 in matched elective contributions, so the plan must distribute $2,500 in matched elective contributions and forfeit the corresponding matching contribution of $2,500 (both adjusted for earnings) to fully correct the remaining $5,000 excess (step 2). In this example, step 3 does not apply.
The employee would receive a total distribution of $13,500.
Reporting and Tax Requirements
The employer should report any corrective distributions made to the participant on Form 1099-R. This means that the participant will need to include the distribution amount as income for the purposes of income tax, but they do not have to pay the 10% additional tax on early employee benefit plan distributions. In addition, it’s important to note that the participant is not allowed to rollover the corrective distribution to another qualified plan or to an IRA.
Any forfeited employer matching or profit-sharing contributions must be transferred to an unallocated account for the purposes of reducing employer contributions in the current year and, if applicable, subsequent years.
Exceeding Section 415(c) limits without correction can jeopardize the tax-qualified status of your employee benefit plan. Remaining in compliance is the best remedy and requires the guidance of an experienced employee benefit plan professional. If you have questions or concerns, JLK Rosenberger wants to help! For additional information on benefit plan limits and correction measures, please call us at 949-860-9890 or click here to contact us. We look forward to speaking with you soon!