The Internal Revenue Code (IRC) imposes limits each year as to how much an employee can contribute to defined contribution retirement plans in that calendar year.
These limits include separate limits in salary deferrals for regular contributions (“elective deferrals”) and for “catch-up” contributions. This column discusses what happens when a federal employee makes “excess deferrals” while participating in the Thrift Savings Plan (TSP) and another qualified retirement plan, as described under sections 401(k), 403(b), 408(k), or 501(c)(18) of the IRC.
During calendar year 2019, federal employees were allowed to contribute a maximum $19,000 in regular contributions, and employees over age 49 as of Dec. 31, 2019 were permitted to contribute an additional $6,000 in “catch-up” contributions to the TSP. These contributions could be made in any combination to the traditional TSP and to the Roth TSP.
However, the total amount contributed via payroll deduction could not exceed $19,000 and $6,000, respectively. For those employees covered by the Federal Employees Retirement System (FERS), an employee’s agency automatic (one percent of SF 50 salary) and agency matching (maximum four percent) contributions were not included in the $19,000 elective deferral limit.
In order to understand how an employee could have made excess deferrals during 2019, the following example illustrates what may happen when an employee retires from federal service:
Joan retired from federal service on Dec. 31, 2018. Shortly before Joan retired, she elected to put almost all of her final two paychecks for leave year 2018 (for pay period 25 ending on Dec. 22, 2018) and for the five days of pay period 26 (Dec. 24-28, 2018) in which Joan was still in federal service (both of these paychecks were paid in January 2019) into the TSP. As it turned out, Joan contributed a total of $8,000 to the TSP with those two paychecks dated in January 2019.
In March 2019, Joan took a new job in private industry. Her new job had a 401(k) retirement plan that Joan immediately participated in, starting in March 2019. Between Mar. 1, 2019 and Dec. 31, 2019, Joan contributed $15,000 to her private company’s 401(k) retirement plan. For calendar year 2019, Joan therefore contributed a total of $8,000 plus $15,000 or $23,000 in salary deferrals to her defined contributions plans, exceeding the 2019 elective deferral limit of $19,000 by $4,000.
The following discussion details what happens when a federal employee made excess deferrals during 2019 while contributing to more than one qualified retirement plan, including the TSP.
Scenario 1: A Federal Employee Contributed to Both the Civilian TSP and the Uniformed Services TSP During 2019
If a federal employee has two TSP accounts; namely, the employee is a civilian employee and contributes to a civilian TSP account and also owns a uniformed services TSP account (the employee is a member of the Ready Reserve and goes on active duty thereby allowing the employee to contribute to a uniformed services TSP account while on active duty).
In January, the TSP will check to see whether the employee’s combined contributions to the civilian TSP and uniformed services TSP accounts exceeded any of the limits. To do so, the TSP will add up the traditional (pre-tax) and Roth (after-tax) contributions made to both accounts. The TSP will then return any contributions that exceeded the applicable limit, along with attributable earnings associated with those contributions before April 15, 2020. The employee need not take any action, including submitting Form TSP-44 (Request for Refund of Excess Employee Contributions) – see below.
Note the following: (1) Traditional tax-exempt contributions made to a uniformed services traditional TSP account (made by a uniformed services member serving in a combat zone) do not count toward the elective deferral limit; (2) elective deferrals and their earnings in a uniform services TSP account will be returned before those elective deferrals in a civilian TSP account; and (3) if an employee made both traditional and Roth contributions during the year, the excess deferrals plus their earnings, will include a proportional amount from both the employee’s traditional TSP and Roth TSP account balances.
Scenario 2: A Federal Employee Contributed to Both the TSP and to Another Qualified Retirement Plan During 2019
Employees who contribute to a qualified retirement plan such as a 401(k) or a 403(b) retirement plan, or the TSP, will know how much they contributed to their respective retirement plans each year when they receive their W-2 forms in January following the year of retirement plan contributions. Specifically, Box 12 of the W-2 shows “elective deferrals”. If an employee contributed to the TSP and to another retirement plan, then the employee’s 2019 W-2 received from the individual’s private employer will show the elective deferrals made during 2019. It is the employee’s responsibility to add the total elective deferrals and “catch-up” contributions from each W-2 to make sure the totals did not exceed the 2019 contribution limits of $19,000 regular contributions and $6,000 “catch-up” contributions, respectively.
If an employee discovers excess deferrals were made, then the employee will have to decide from which retirement plan to request a refund of excess deferrals. A suggestion is that the employee should request a refund of excess deferrals from the plan that will result in the least amount of loss of employer matching. For example, in the case of a FERS-covered employee, the employee received the maximum match of four percent provided that the employee deferred at least five percent of his or her salary during 2019.
How Does the TSP’s Refund Process Work?
Earlier in January 2020, the TSP attached Form TSP-44 (Request for Refund of Excess Employee Contributions) to the TSP Fact Sheet Annual Limit on Elective Deferrals (https://www.tsp.gov/PDF/formspubs/tspfs07.pdf). If an employee made excess deferrals to the TSP and to another retirement plan during 2019, and the employee decides to request a refund of excess TSP contributions, then the employee (or annuitant) needs to complete Form TSP-44 and send the completed form by March 15 2020. A timely submitted Form TSP-44 will result in the return of the excess TSP deferrals and associated earnings to the employee or annuitant.
To request a refund of excess deferrals, an employee or an annuitant must submit the latest version of Form TSP-44. To know whether the most recent version of Form TSP-44 is being used, the employee or annuitant should look at the upper right-hand corner, under the form name, for the tax year. If a request for return of excess contributions made in 2019 is being made, then the form should say “Tax Year 2019”.
Form TSP-44 must be FAXED or mailed and postmarked to the address provided on Form TSP-44 no later than March 15, 2020 in order to receive a refund of excess deferrals made during 2019. Form TSP-44 will be removed from the Fact Sheet Annual Limit on Elective Deferrals immediately after March 15. Any question can be directed to the TSP at 1-877-968-3778 (outside of the U.S. and Canada, call 404-233-4400).
Tax Consequences of Making Excess Deferrals in Any Tax Year
Excess deferrals are treated as treated as income in the year in which the employee made the contributions, whether or not the excess deferrals are refunded to the employee. The total amount of deferred income is reported by each employer in Box 12 on an employee’s Form W-2.
Employees who have made traditional excess deferrals must report the total amount of the excess on the employee’s individual income tax return as taxable wages for the year in which the employee made the excess deferrals. Roth excess deferrals are also taxable wages for the year in which an employee made the excess deferrals. But the amount that is supposed to be reported as excess Roth deferrals is already reported as income in Box 1 of the employee’s Form W-2.
If an employee elects to receive excess deferrals as a refund from the TSP, then the employee will receive IRS Form 1099-R (Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) which will indicate the amount of the excess that was refunded. If an employee has already filed his or her individual tax return for the year in which the excess was contributed, and the excess was not included as taxable wages, then the employee will need to file an amended tax return.
Treatment of Earnings on Excess Deferrals for Tax Purposes
Earnings distributed with excess deferrals are considered taxable income in the year in which they are distributed. Any earnings on excess Roth TSP contributions are taxable income as well.
Employees will receive a separate IRS Form 1099-R indicating the amount of the earnings. The earning must be reported on an employee’s tax return for the year in which the distribution is made.
Treatment of Agency/Uniform Services Marching Contributions That Were Associated with Excess Deferrals
An FERS-covered employee’s (or uniformed service member) agency or service will be notified that the employee or service member has requested that excess deferrals and associated earnings be returned to the employee. The employee’s agency or service is required to remove the agency /service matching contributions associated with these excess deferrals.
Two other tax-related issues with respect to excess deferrals:
- Early withdrawal and IRS penalty. If the distribution of excess deferrals including associated earnings is made by April 15 of the tax year following the year in which the excess deferral was made, then the distribution will not be considered an early withdrawal and not subject to the IRS’ 10 percent early withdrawal penalty. For excess deferrals made in 2019, the distribution of excess deferrals must be made no later than April 15, 2020.
- Consequences of not making a distribution of excess deferrals by April 15 of the following tax year. After April 15 of the following tax year, a TSP participant cannot request to have the excess deferrals made in the previous year refunded. Instead, the distribution will remain in the TSP participant’s account. As such, if the distribution is the traditional (pre-tax) TSP, then the TSP participant will be taxed twice on the distribution, namely; once in the year in which the excess deferral was made and then again when the TSP participant separates and withdraws the traditional TSP account. Earnings on the excess deferrals are taxed only once when the account is withdrawn. If the distribution is Roth (after-tax) TSP and is not made by the April 15 deadline then the Roth TSP excess deferrals will not be treated as after-tax contributions. This means that the double-taxation rule stated above will also apply to excess Roth contributions. The Roth TSP participant will also owe taxes on the earnings attributable to the excess Roth contributions even if the Roth TSP participant meets the qualified distribution requirements.