4049 / What are the consequences of exceeding the limit on elective deferrals to a tax sheltered annuity plan?

Any elective deferral in excess of the applicable limit is included in the individual’s gross income for the year of deferral. If any such amount is included, the individual may, no later than April 15 of the following year, allocate the excess deferrals among the plans under which the deferrals were made and, if plan language permits it, the plans may distribute to the individual the amounts so allocated together with income allocable to the amounts no later than April 15 of that year.¹ A timely distribution may be made regardless of otherwise applicable prohibitions on distributions ( Q 4035).²

Because an excess deferral is not excluded from gross income, the excess amount distributed under these rules by April 15 is not included in income as a distribution. Any income on the excess deferral is included in income in the taxable year in which distributed.³

A distribution of less than the entire amount of excess and income is treated as a pro rata distribution of deferral amount and income.⁴ A distribution by April 15 of excess deferrals and income is not subject to tax as a premature distribution under IRC Section 72(t).⁵ A distribution of an excess deferral is not a distribution for purposes of meeting the minimum distribution requirements.⁶

If the excess deferral is not distributed by April 15, it is subject to the regular prohibitions on withdrawals and is not included in the investment in the contract, or basis, even though it has been included in income. Thus, excess deferrals are includable in gross income when later distributed.⁷ A withdrawal that occurs before the excess deferral was made does not count as a distribution of an excess deferral.⁸

The amount of salary reduction excludable in a year may actually be less than the amount permitted under the limit if the overall limit is less ( Q 4042). Contributions by salary reduction are not deductible employee contributions; they are employer contributions that are excludable within limits ( Q 4035, Q 4042).