Excess deferrals occur when a 401(k) participant defers a greater amount than the annual IRS limit permits. The annual deferral limit was $22,500 for 2023 and $23,000 for 2024. For participants 50 years old and older, an additional $7,500 can be deferred.

When this limit is exceeded, excess deferrals and earnings need to be removed from the plan and returned to the participant. Employer matching on this excess likewise must be forfeited if it was calculated and funded during the year. Distribution of these excess funds must occur by April 15th.

Even with payroll software that limits the deferrals, there are several situations in which excess deferrals might occur:

• A participant who begins working for you may have made deferrals to a previous employer’s plan during the same calendar year. After meeting any eligibility and entry requirements, they then make deferrals into your plan. Combined, these deferrals may exceed the annual limit, which is individual rather than per-plan. This error is often discovered during the preparation of the participant’s tax return, and correction requests are typically received in the first few months of the year.
• When you make a change to your payroll providers or payroll software, deferral limits may be exceeded if year-to-date deferral information is not transferred correctly.
• If a participant’s date of birth was input incorrectly into your payroll software, the participant may be inadvertently permitted to make a catch-up contribution, even though they haven’t reached age 50.

You may be asked to perform any necessary corrections regardless of whether or not the error occurred on your watch. The best way to prevent excess deferrals is to be sure that all deferrals are tracked in your payroll and that dates of birth are correct for all participants making catch-up contributions. Most payroll software has a field to input deferrals made outside of that software; if you hire a new employee, ask for their year-to-date deferrals, and ensure that this information is given to your payroll provider or entered into your software. If you make a payroll change during the year, check the year-to-date deferrals and ensure that they are correct for each employee.

Sources: Pension Pro

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