Over-Contribute to a 401(k)? Here’s What I Did

On today’s episode of “Katie’s enthusiasm for early retirement gets taken a bridge too far,” we’re going to discuss what to do (or rather, what I did) when I realized I put too much in my 401(k) plans for the year.

And not just, like, a few hundred dollars too much – about $10,000 too much.

If you’re like, Whoah, sis, that hardly seems like an accidental amount, keep reading.

Annual 401(k) limits

Most people are aware of the “regular” 401(k) limit, $19,500 in 2021 (and $20,500 in 2022! Holla!).

This is the limit that an employee can contribute to a 401(k) plan, known as an “elective deferral” in the eyes of our boiz at the IRS. But did you know that there’s a backdoor speakeasy version of the 401(k) that you can only access if you know the password and flirt with the bouncer’s weird brother? Yep – the actual plan limit is $58,000 per individual, per year ($61,000 in 2022; huzzah!).

How would one manage to contribute $58,000 to a 401(k) plan? There are two major ways.

Ways to contribute more than $19,500 to a 401(k) plan

The first? You could have an employer with a generous match (though I’ve never heard of one that fills up the bucket all the way to $58,000). Importantly, your employer’s contribution counts toward your $58,000 limit. Makes sense.

The actual way that most employees end up with $58,000 in their 401(k) is through making “after-tax” contributions – the precursor to what’s known in the FI community as the elusive Mega Backdoor Roth IRA.

Mega Backdoor Roth IRA

The Mega Backdoor Roth IRA basically allows a 401(k) plan participant to make contributions in excess of their regular-shmegular $19,500 and their employer’s contribution, up to $58,000 per year (in 2021), that get converted to Roth. Hence the name, “Mega” Backdoor Roth IRA.

Solo 401(k)

So there’s that–but there’s another major way that someone could end up with $58,000 of contributions in 401(k)s for the year, and that’s the Solo 401(k).

If you have self-employment income, you’re able to also make employer-only contributions to a Solo 401(k) (also sometimes called an “Individual 401(k)”). These are “non-elective” deferrals.

Your employee contributions (‘elective’ deferrals) are capped at $19,500 across plans in 2021 (regardless of how many plans you have), so you can’t contribute to both as an employee, but you can contribute up to 20% of your net business income as your own “employer” if you have self-employment income, too.

How I over-contributed to my 401(k)s

The short answer? Carelessness.

I had a 401(k) at work, but switched jobs in the middle of the year – so when I declared my new contribution amount, I hadn’t really given much thought to the fact that it wouldn’t “match up,” so to speak, with the contributions I had already made.

To make matters more complicated, I also had a Solo 401(k) into which I had been desperately shoveling business income, trying to lower my tax bill.

It hit me like a dump truck one morning a few minutes after making a $15,000 employer contribution to my Solo 401(k).

“Wait a second,” I thought, “I think I may have just way over-contributed.”

I hadn’t been paying attention to how much had been put into 401(k) plans throughout the year, and now I was paying for it.

How I realized I had over-contributed

I looked at my statements for the year for each 401(k) plan and tried to find the most efficient way to gauge my contributions. One 401(k) provider summarized the year nicely for me, while another literally made me whip out a calculator and start adding them up. Here’s what I found out:

TOTAL EMPLOYEE CONTRIBUTIONS TO BOTH WORK PLANS

$19,726.86

…oops. I knew I should’ve paid closer attention when I switched jobs.

TOTAL EMPLOYER CONTRIBUTIONS TO MY SOLO 401(K)

$68,406.53

…double oops. 

In order to right my wrongs, I decided to start by pulling roughly $10,500 out of my Money with Katie 401(k).

Correcting your contributions

My Solo 401(k) provider is Vanguard, so that’s where I started. I literally Googled “corrective measures form Vanguard Solo 401(k).” You can do the same if you have a different provider; it’s unlikely you’ll go over at work (most 401(k) plans through big employers have stopping mechanisms to make sure you don’t over-contribute) but if you do for the same reason I did (switching jobs mid-year), you can call them and ask for a corrective measures form.

Vanguard corrective measures form

Here’s a link to the form for Vanguard Solo 401(k)s, as of 2021. I ended up calling (the number is 800-376-9162, if you need it) to get help, because I wasn’t sure which option to choose (open the form and you’ll see what I mean).

And man, I’m glad I did, because Ryan from Vanguard hooked it up. He gave me some good advice:

• Don’t choose “Mistake of Fact,” as that’s “like asking the IRS to audit you,” according to my man Ryan

• The choice he guided me toward was the “excess annual additions,” Option B

• You’ll be asked for a “fund number” and “account number”; the fund number is for the 401(k) plan, while the account number is from your personal investor account

After I finished filling it out, I promised Ryan my firstborn son and hung up the phone. After printing it out, I realized I’d need to locate an envelope big enough and a stamp (not easy feats in 2021), and that’s where I decided it was a problem for next week.

(I just want to make sure I get it mailed off before the end of the year, as 401(k) contributions run January 1 to December 31 and I’m not interested in the complications of making these changes after the fact.)

What happens to the funds?

This part was new to me: Apparently (with Vanguard, at least), the funds get moved into something called a “suspense account,” which is a hilarious and fitting name.

The suspense account can stay invested, so he advised me to put whatever index fund I wanted them invested in while they wait to be contributed again.

Starting January 1, 2022, I can pull them out of the expense account and plop them back in the 401(k) as a 2022 contribution.

So the $10,500 basically moves out for two weeks, finds itself on an eat/pray/love journey to the suspense account, and then moves right back in.

(To be clear, I have to go and re-contribute them; it’s not automatic. When I went to do this in 2022, I couldn’t find this suspense account anywhere in my Vanguard portal, so I ended up having to call again. Turns out you have to literally write them a letter describing which funds you want moved where and include your account numbers for both the suspense account and Solo 401(k), the amount you want moved, and the fund number for what you want it invested in.)

The bummer is that the $10,500 doesn’t lower my 2021 tax liability, it lowers my 2022 tax liability.

So what’s a girl to do? I still have business income I want to defer, man!

Why a SEP IRA might be easier for you if you have self-employment income and W2 wages

How much can you put in a SEP IRA?

This’ll sound familiar: 20% of your net business income. 

The SEP IRA also allows up to $58,000 in employer contributions (but note that you couldn’t fill up both a Solo 401(k) and a SEP IRA for the same business – that $58,000 limit also applies to income sources).

The SEP IRA is (sometimes) an easier self-employment pre-tax account to leverage because it doesn’t require the plan paperwork or EIN that the Solo 401(k) requires.

Phew. Got all that?

Now to figure out how to go back and retroactively remove my accidental Roth IRA contributions… it never ends, I tell you! (At least it’s good for content.)