What happens if an employee's contributions exceed the allowed limits?

When an employee's contributions exceed the allowed limits for a 401(k) plan, the correct course of action is that the excess contributions must be refunded to the employee. The Internal Revenue Service (IRS) sets annual contribution limits to ensure that retirement plans remain tax-advantaged and not used as tax shelters by high earners.

If an employee contributes above these limits, the excess amount can create tax complications for both the employee and the plan. To prevent these issues, the plan administrator must ensure that the excess contributions are identified and returned to the employee. This refund must be processed prior to the tax filing deadline for the year in which the excess contribution was made.

If these excess amounts are not refunded in a timely manner, they may be subject to additional taxation, which could lead to tax penalties. Therefore, properly managing excess contributions by refunding them is essential for maintaining compliance with IRS regulations and ensuring that employees do not face unintended tax consequences.