Too Rich for a 401(k)?

This is the time of year a lot of readers are confused by what I call "boomerang 401(k) contributions." This happens when company retirement plans kick out some of the contributions made during the previous year by highly compensated employees -- generally those who made more than $100,000 in 2007.

Such corrective distributions are required if the plan discovers that highly paid employees contributed too much of their salaries compared with the amount contributed by lower-paid workers.

This test is required by Congress to prevent the tax benefits of 401(k)s from going disproportionately to higher-paids. Because the test can't be completed until after the plan year closes, the checks for any excess contributions are mailed out after January 1.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just ~~$107.88~~ $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

https://cdn.mos.cms.futurecdn.net/flexiimages/y99mlvgqmn1763972420.png

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

But how to do you report that money on your tax return? It depends on the timing.

If a plan makes such a corrective distribution by March 15, then you report it as part of your 2007 salary -- even though it means reporting more salary than is shown on your W-2. After all, the W-2 amount was set assuming all the 401(k) money you contributed would avoid tax. The corrective distribution retroactively reduces the amount in the tax shelter and hikes your taxable pay.

If the company makes the payout after March 15, it counts as 2008 salary.

Oh, yeah: If you filed your 2007 return before you got a corrective distribution -- and you got the money by March 15 -- you're supposed to file an amended return using Form 1040X to report and pay tax on the extra money.

McCormally retired in 2018 after more than 40 years at Kiplinger. He joined Kiplinger in 1977 as a reporter specializing in taxes, retirement, credit and other personal finance issues. He is the author and editor of many books, helped develop and improve popular tax-preparation software programs, and has written and appeared in several educational videos. In 2005, he was named Editorial Director of The Kiplinger Washington Editors, responsible for overseeing all of our publications and Web site. At the time, Editor in Chief Knight Kiplinger called McCormally "the watchdog of editorial quality, integrity and fairness in all that we do." In 2015, Kevin was named Chief Content Officer and Senior Vice President.