Publication 571: Tax-Sheltered Annuity Plans (403(b) Plans); Excess Contributions

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Table of Contents

If your actual contributions are greater than your MAC, you have an excess contribution. Excess contributions can result in income tax, additional taxes, and penalties. The effect of excess contributions depends on the type of excess contribution. This chapter discusses excess contributions to your 403(b) account.

Preventing Excess Contributions

To prevent excess contributions, you should figure your MAC at the beginning of each year using a reasonable estimate of compensation. If, at any time during the year, your employment status or your compensation changes, you should refigure your MAC using a revised estimate of compensation.

At the end of the year or the beginning of the next year, you should refigure your MAC based on your actual compensation and actual contributions made to your account.

If the actual contributions to your account are greater than your MAC, you have excess contributions.

Certain excess contributions in a 403(b) account can be corrected. The effect of an excess 403(b) contribution will depend on the type of excess contribution.

Types of excess contributions.

If, after checking your actual contributions, you determine that you have an excess, the first thing is to identify the type of excess that you have. Excess contributions to a 403(b) account are categorized as either an:

Excess annual addition, or
Excess elective deferral.

An excess annual addition is a contribution that is more than your limit on annual additions. To determine your limit on annual additions see chapter 3 (chapter 5 for ministers or church employees).

In the year that your contributions are more than your limit on annual additions, the excess amount will be included in your income.

Amounts in excess of the limit on annual additions that are due to elective deferrals may be distributed if the excess contributions were made for any one of several reasons, including:

If your 403(b) account invests in mutual funds, and you exceed your limit on annual additions, you may be subject to a 6% excise tax on the excess contribution. The excise tax does not apply to funds in an annuity account or to excess deferrals.

You must pay the excise tax each year in which there are excess contributions in your account. Excess contributions can be corrected by contributing less than the applicable limit in later years or by making permissible distributions.

Permissible distributions.

A permissible distribution is a distribution that can be made when one of the following events occurs.

You reach age 59½.
You have a severance from employment.
You die.
You become disabled.
In the case of salary reduction contributions, you encounter financial hardship.

Reporting requirement.

You must file Form 5330 if there has been an excess contribution to a custodial account and that excess has not been corrected.

An excess elective deferral is the amount that is more than your limit on elective deferrals. To determine your limit on elective deferrals, see chapter 4.

Your employer's 403(b) plan may contain language permitting it to distribute excess deferrals. If so, it may require that, in order to get a distribution of excess deferrals, you either notify the plan of the amount of excess deferrals or designate a distribution as an excess deferral. The plan may require that the notification or designation be in writing and may require that you certify or otherwise establish that the designated amount is an excess deferral. A plan is not required to permit distribution of excess deferrals.

Correction of excess deferrals during year.

If you have excess deferrals for a year, a corrective distribution may be made only if both of the following conditions are satisfied.

You or your employer designate the distribution as an excess deferral to the extent you have excess deferrals for the year.
The correcting distribution is made after the date on which the excess deferral was made.

Correction of excess deferrals after the year.

If you have excess deferrals for a year, you may receive a corrective distribution of the excess deferral no later than April 15 of the following year. The plan can distribute the excess deferral (and any income allocable to the excess) no later than April 15 of the year following the year the excess deferral was made.

Tax treatment of excess deferrals.

If the excess deferral is distributed no later than April 15, it is included in your income in the year contributed and the earnings on the excess deferral will be taxed in the year distributed.

Example 1.

William's MAC for 2002 was $11,500. All of William's contributions were made through salary reductions. He contributed $12,500 in 2002, an excess deferral of $1,000. He notified his plan administrator and his employer of the excess contribution on March 14, 2003, and the excess deferral was distributed on April 13, 2003. Because the excess deferral was distributed before April 15, 2003, the excess deferral will be included in his income for 2002, and any earnings on the excess is included in his income in the year they are distributed.

If you do not receive a distribution of excess elective deferrals by April 15 of the year following the year it is contributed, it will be included in your earned income in the year contributed and in the year distributed.

Example 2.

Assume that, in Example 1, a distribution of the excess deferral was not made to William by April 15, 2002. Because the distribution was not made timely, the excess deferral will be taxed in 2001 (the year contributed) and again in the year the excess deferral is distributed. The earnings on the distribution will be taxed in the year they are distributed.