Are there penalties on over-contributions to 401k plans?

• If you have contributed more than your annual limit to your 401k plan in the year, you will be subject to double-taxation if you do not correct it. There are no penalties on the over-contribution, but you will be disallowed the income tax deduction in the year of contribution and will have to pay tax on the withdrawal. This means that you will pay tax twice on the same contribution, which hurts you both now and at retirement.
  
  

Should I withdraw over-contributions?

• The best way to correct an over-contribution to a 401k plan is to request a corrective distribution from your employer. This allows you to withdraw any excess contribution along with its related income earned to date. You have until April 15th of the following year to make the withdrawal. If you miss this deadline, the double-taxation applies and you cannot correct it in the future. When the contribution is withdrawn, you include it in your income along with any investment income it has earned. The net impact on your tax return is that the inclusion in income negates the deduction on your W-2 and you will pay tax on the investment income portion.
  
  

What happens to employer-matched over-contributions?

• Many employer-sponsored 401k plans include a matching component, meaning that they will deposit an amount equivalent to your contributions up to a certain level into your plan. As long as the employer is within the matching guidelines, there is no double-taxation on the employer contribution. The totals of all contributions (both employer and employee) to a 401k plan cannot exceed 100 percent of the employee's salary to a maximum of $49,000 in both the tax years 2010 and 2011. If the employer contributions do not breach these limits, they can stay in the plan.
  
  

How do I make sure I don't over-contribute in the future?

• If you have one job and one 401k plan throughout the year, you will not likely have excess contributions. Your employer tracks what has been contributed throughout the year on your behalf and will halt contributions when you hit your limit. If you have multiple employers, however, it is up to you to track how much you have already contributed in the year and how much room you have left. When setting up your new 401k plan, subtract what you have already contributed in the year from the maximum allowed and divide that amount into the number of pay periods left in the year. This is the amount you should tell your new employer to contribute to your plan.