The 2015 before-tax 401(k) contribution limit is $18,000 ($24,000 for individuals over 50) per taxpayer. If you have more than one employer during the year, this limit applies to the sum of the before-tax contributions made to all employers’ plans.
The Section 415©(1)(A) limit is $53,000 per plan (not per taxpayer). The $53,000 limit includes all before-tax contributions, after-tax contributions, employer contributions, etc. If you have more than one employer, this limit applies separately to each employer.
“Before-tax” contributions are deductions from your salary on which you will not pay taxes. However, you will pay taxes when you withdraw them from the plan (typically when you retire). “After-tax” contributions are deductions from your salary for which you get no tax deduction and on which you will pay no taxes when you withdraw them.
Very few employers allow after-tax contributions.
When you only have one employer during a given year, unless the employer screws up royally, there is no way you will exceed either limit. Some employers who allow after-tax contributions will automatically switch the contributions from before-tax to after-tax as soon as the employee reaches the annual before-tax limit. Other employers will just stop taking contributions.
The problem arises when you have more than one employer during a given year. Employers are not require to keep track of what you have contributed to a different employer’s plan or to coordinate their plans, so an employee may end up exceeding the $18,000 before-tax limit.
Let’s say an employee under age 50 has two employers and makes a $10,000 before-tax contribution to each employer’s plan in the same year. The employee has contributed a total of $20,000 which is $2,000 over the limit.
Option 1: The employee does nothing. The employee will receive two different W-2s (because he had two employers) each showing that his taxable pay was reduced by $10,000. When the employee fills out his Form 1040, he will have to add $2000 to the total on Line 7 and pay taxes on the $2000. Later (typically when he retires) he will STILL have to pay taxes on the extra $2000 when he withdraws it from the plan. In other words, he will get taxed twice on the $2000.
Option 2: The employee may request either employer to make a $2000 corrective distribution. Neither employer is required to grant the request. But if a corrective distribution is made, the employer must distribute the $2000 plus any earnings on the $2000. The $2000 and the earnings will be taxable. The corrective distribution must be completed by April 15th of the following year. A common mistake that people make is that they realize the problem after April 15th and demand a corrective distribution then. If you take the distribution after April 15th, you will both pay taxes on the over-contribution and on the distribution. If you cannot complete the corrective distribution by April 15th, just leave the money in your 401(k).
Option 3: You can prevent the over-contribution from even happening by requesting the second employer to take after-tax contributions instead of before-tax contributions, if the employer allows it.
Now you may read in many places in the net, that there is an annual penalty on over-contributions until you withdraw them. There is NOT. The people who write this are confusing 401(k) plans with IRA plans. There is a 6% annual over-contribution penalty for IRAs. This penalty does not apply to a 401(k).