Understanding Excess Salary Deferrals in Federal Employee Retirement Plans

Are you a federal employee participating in the Thrift Savings Plan (TSP) and another qualified retirement plan? Have you ever wondered what happens if you make excess salary deferrals to these plans? In this blog post, we will discuss the implications of making excess deferrals and what steps you can take to rectify the situation.

The Internal Revenue Code (IRC) sets limits each year on how much an employee can contribute via payroll deduction to defined contribution retirement plans. These limits include separate limits for regular contributions and “catch-up” contributions for employees over the age of 50. If you find yourself in a situation where you have made excess deferrals, it’s important to understand the consequences and how to address them.

Let’s consider an example: Joan, a federal employee, retired at the end of December and made excess contributions to her TSP account. She then started a new job in March and contributed to a 401(k) retirement plan, exceeding the annual limits for elective deferrals. In this scenario, Joan would need to take action to correct the excess deferrals and avoid potential tax implications.

If you find yourself in a similar situation, here’s what you need to know:

1. If you have multiple TSP accounts (civilian and uniformed services), the TSP will check if your combined contributions exceed the limits and return any excess contributions with earnings before April 15 of the following year.

2. If you contribute to both the TSP and another qualified retirement plan, you will need to reconcile your total contributions from each plan when you receive your W2 forms in January. If you discover excess deferrals, you can request a refund from the plan that minimizes the loss of employer matching.

3. The TSP’s refund process involves submitting Form TSP-44 by March 15 of the following year to request a refund of excess contributions. Failure to address excess deferrals can result in tax consequences and potential double taxation on distributions.

4. It’s important to understand the tax implications of excess deferrals, including reporting them as taxable income and potential penalties for early withdrawals. Earnings on excess deferrals are also considered taxable income when distributed.

5. Contributions to IRAs are not included in excess deferrals, so you can still maximize your contributions to both the TSP and an IRA without exceeding the limits.

In conclusion, if you find yourself in a situation where you have made excess deferrals to your retirement plans, it’s crucial to take action promptly to avoid potential tax consequences. Understanding the rules and procedures for correcting excess contributions can help you navigate this complex issue and ensure compliance with IRS regulations. If you need assistance with managing your retirement accounts and tax planning, consider consulting a financial advisor or tax professional for guidance.