Federal employee elective deferrals are the amounts that an employee asks an employer to deduct from his or her salary and contribute to a defined contribution plan sponsored by the employer. Defined contribution plans include 401(k) and 403(b) plans and the Thrift Savings Plan (TSP).
Note that IRAs and defined benefit plans such as CSRS and FERS annuities and military pensions are not defined contribution plans and have separate contribution limits.
Traditional before-taxed (“traditional”) retirement plan and after-taxed (“Roth”) retirement plan contributions in total cannot exceed the annual “elective deferral” limit that is set by the IRS. Elective deferrals do not include “catch-up” contributions. Employer automatic and employer matching contributions are not included in the elective deferral limit because those contributions are not considered part of an employee’s salary. Section 402 of the Internal Revenue Code limits the amount of salary an employee may elect to defer to all defined contribution plans during a calendar year
For the year 2020, the elective deferral limit was $19,500. Federal employees will know how much of their salaries were set aside to the TSP (that is salaries set aside in total to the traditional TSP and the Roth TSP) as elective deferrals for 2020 by noting box 12 (code “D) of their 2020 W2 forms, which they should receive sometime before February 1, 2021.
Exceeding the elective deferral limit
If a federal employee contributed only to the TSP during 2020, then the employee’s payroll office would have limited the employee’s TSP elective deferrals to $19,500. A potential problem occurs when an employee contributes to more than one defined contribution plan and contributes more than the elective deferral limit for that year. This column discusses what an affected employee has to do in case the employee exceeds the $19,500 elective deferral limit for 2020.
The following example illustrates how an employee could exceed the annual elective deferral limit during 2020:
Jeremy, age 45, left the XYZ Company on June 30, 2020. Prior to leaving the XYZ Company, Jeremy contributed $12,000 to the company-sponsored 401(k)-retirement plan between Jan. 1 and June 30, 2020.. Jeremy became a federal employee on August 1, 2020 and between August 1, 2020 and Dec. 31, 2020, contributed $10,000 to the TSP. For the year 2020, Jeremy contributed a total of $22,000 to his defined contribution plans, exceeding the maximum of $19,500 by $2,500.
An employee who contributed more than $19,500 during 2020 to more than one defined contribution plan, the TSP (both traditional and Roth), 401(k) (both traditional and Roth), and 403(b) (traditional and Roth) plans during 2020 can request a refund of excess of contributions from any one or all of these plans.
It needs to be emphasized that a federal employee who was younger than age 50 throughout all of 2020 (that is, the employee was born after December 31, 1970) could not have contributed via payroll deduction more $19,500 to the TSP during 2020. This is because the TSP limited a federal employee’s regular contributions in total to the traditional TSP and Roth TSP during 2020 to $19,500.
It is only if an employee participated in more than one defined contribution plan during 2020 that the employee could have exceeded the IRS’ elective deferral limit. The employee after looking at all of his or her 2020 W2 forms determines that the employee contributed in total more than $19,500 to these retirement plans and therefore at this time has to decide which plan to request a refund of excess contributions.
To request a refund of excess contributions from the TSP, the employee needs to complete Form TSP-44 (Request for Refund of Excess Employee Contributions) — downloadable here under “Annual Limit on Elective Deferrals” – Fact Sheet.
A request for a refund of excess 2020 TSP contributions requires that Form TSP-44 have “Tax Year 2020” in the right-hand corner. To know whether one has the most recent version of Form TSP-44, look in the upper right-hand corner of the form for the tax year, in this case for Tax Year 2020.
Form TSP-44 must be faxed or post-marked and mailed to the address provided on the form no later than March 15, 2021. The TSP will then process the refund by April 15, 2021.
Excess traditional TSP contributions are treated as income in the year in which the federal employee made the contributions, whether or not the excess contributions are refunded to the employee. The total amount of traditional TSP contributions is reported in Box 12 of the employee’s 2020 Form W2.
The total amount of excess traditional TSP contributions during the year 2020 is reported on the employee’s 2020 federal individual tax return as “taxable wages”. Excess Roth TSP contributions during the year 2020 are also considered as taxable wages for the year 2020, but the amount required to be reported as taxable wages is already included as income on the employee’s 2020 Form W2 Box 1 as taxable wages).
Employees who elect to receive excess TSP contributions as a refund from the TSP will receive IRS Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.). This distribution will also be reported to the IRS.
Tax treatment of earnings on excess TSP contributions
Earnings distributed with excess TSP contributions are considered taxable income in the year they are distributed (unlike the excess TSP contributions, which are considered taxable income in the year in they are contributed. If there are excess Roth contributions, then the Roth TSP participant will owe taxes on the Roth TSP earnings as well, even if the Roth TSP participant meets the IRS requirements to receive Roth TSP earnings tax-free (that is, it has been 5 years since January 1 of the year in which the Roth TSP participant made his or her first Roth TSP contribution and the Roth TSP participant is at least age 59.5 or permanently disabled).
The TSP participant will receive a separate IRS Form 1099-R indicating the amount of the earnings. The participant must report this amount as income in the year in which the distribution is made. The distribution will be reported to the IRS.
What happens to the Agency matching TSP contributions associated with excess deferrals?
The agency of an employee who made excess deferrals to the TSP during 2020 will be notified that the employee requested that excess TSP contributions and associated earnings with those excess contributions will be returned to the employee. The employee’s agency is then required to remove the agency matching contributions associated with those contributions.
If the agency fails to remove the matching contributions from the employee’s TSP account within one year of the date the contributions were made, then the TSP will remove the matching contributions and use the matching contributions to offset TSP administrative expenses.
Is the distribution of excess deferrals considered an “early withdrawal” and therefore subject to the IRS’ 10 percent early withdrawal penalty?
If an employee’s excess TSP contributions made during 2020 are distributed by April 15, 2021, then the distribution will not be considered as an early withdrawal.
After 15, 2021, an employee cannot request to have the excess amount of TSP contributions made during 2020 be refunded. Instead, the excess contributions will remain in the TSP participant’s account.
If the contributions are traditional (before-taxed) contributions, then the TSP participant will then be taxed twice on the amount of excess contributions; namely, in the year 2020 and then again in the year after the employee separates from federal service and withdraws the contributions from the traditional TSP account. The earnings associated with the excess TSP contributions will be taxed only once when they are withdrawn.
If the excess TSP contributions are Roth (after-taxed) contributions, the excess Roth TSP contributions will not be treated as after-taxed contributions. This means that the double-taxation rule in the previous paragraph applies to excess Roth TSP contributions.
Also, the Roth TSP participant will pay income tax on the earnings associated with the excess Roth TSP contributions – even if the Roth TSP participant has met the Roth qualified distribution requirements.