The Bonus Deferral, the Excess Deferral, and the ADP Refund That Might Not Have to Leave
Your firm administers a calendar-year, non-safe-harbor 401(k) plan that is tested on a prior-year basis and matches 100% of the first 4% of pay. The 2023 NHCE ADP was 3.50%. Two HCEs were eligible in 2024: the owner, age 52, who earned $300,000 and had $24,000 of deferrals, and a second HCE, age 45, who earned $200,000 and deferred $8,000. Of the owner's total, $4,000 was withheld from a December bonus and deposited with the January 2025 payroll, but the bonus itself was 2024 compensation. No participant came close to the 415(c) limit and no other plans are maintained. On February 3, 2025 the administrator asks you to close out the 2024 ADP test and tell her exactly what must leave the plan, by when, and how each amount is reported.
1. Determine the 2024 ADP test result, the dollar amount of the corrective distribution, and which HCE must receive it.
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Step 1 - What counts as a 2024 deferral. The $4,000 bonus deferral was withheld from 2024 compensation, so it is a 2024 elective deferral even though it was deposited in January 2025. The §402(g) limit follows the year the amounts would have been received but for the election, not the deposit date. Owner's 2024 deferrals = $24,000.
Step 2 - Strip out the catch-up. The owner is 52 and the plan permits catch-up, so the $1,000 above the $23,000 §402(g) limit is recharacterized as a catch-up contribution and is excluded from the ADP test. Deferrals used in testing:
- Owner: $23,000 ÷ $300,000 = 7.6667%
- Second HCE: $8,000 ÷ $200,000 = 4.0000%
Step 3 - HCE ADP. ($23,000 + $8,000) ÷ $500,000 = 6.20%.
Step 4 - Permitted HCE ADP. Prior-year NHCE ADP 3.50%; the limit is the greater of 125% (4.375%) or NHCE ADP + 2 (5.50%), but never more than 200% of NHCE ADP (7.00%). Limit = 5.50%.
Step 5 - Excess. 6.20% − 5.50% = 0.70% × $500,000 aggregate HCE compensation = $3,500.
Step 6 - Leveling. Reduce the highest-paid HCE to the next highest rate before reducing anyone else. Cutting the owner from 7.6667% to 4.0000% would remove $11,000 - far more than needed. Reduce the owner only, by $3,500 ÷ $300,000 = 1.1667 points, leaving her at 6.50%.
Result: a $3,500 corrective distribution attributable entirely to the owner (plus allocable earnings).
2. Can any of the corrective amount stay in the plan? Explain the catch-up recharacterization mechanics and the reporting.
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Yes - the entire $3,500 can stay in the plan.
Why. A corrective distribution of excess contributions is recharacterized as a catch-up contribution (and is not distributed) to the extent the HCE:
- is catch-up eligible (age 50 or older - she is 52);
- has remaining catch-up room under §402(g); and
- the plan permits catch-up contributions.
Room available. 2024 catch-up maximum $7,500 minus the $1,000 already treated as catch-up = $6,500. The $3,500 ADP excess is within that room, so it converts to catch-up and is retained.
Consequences.
- No distribution, no 1099-R, no Form 402(f) notice.
- The amount is not an excess contribution, so no 10% excise tax under §4979 and no 2½-month deadline problem.
- It is excluded from the ADP test and is not an annual addition for 415(c) purposes.
- W-2 reporting: there is no separate catch-up code for pre-tax 401(k) deferrals. The owner's full $24,000 is reported in Box 12 with code D (code AA is only for designated Roth deferrals).
- The plan should still document the test, the recharacterization, and the catch-up room calculation.
3. How would the deadline, taxation, and reporting change if the owner were 48 instead of 52?
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No catch-up shelf exists. At 48 she is not catch-up eligible, so nothing can be recharacterized and both amounts must be paid out.
The $1,000 excess deferral. Because $24,000 exceeds the $23,000 §402(g) limit, $1,000 is an excess deferral. It must be distributed, with earnings, by April 15, 2025 to be included in income only for 2024 (the year of deferral). If it is paid after that date it is taxable in 2024 and again when distributed. Excess deferrals are excluded from the ADP test, so the ADP math above is unchanged.
The $3,500 ADP excess contribution. Must be distributed with earnings by the last day of the 2½-month period after the plan year (March 15, 2025) to avoid the 10% excise tax under §4979 and to preserve the employer's deduction for 2024. If paid later, the employer pays the excise tax, deducts in the year of payment, and the amount is taxable to her in the year distributed.
Other points. Both amounts are reported on Form 1099-R (no 20% mandatory withholding; 10% voluntary withholding may apply on the excess contribution). Because she is under 59½, the §72(t) 10% additional tax applies to amounts not otherwise excepted. Plan-level 402(g) and ADP excesses are separate corrections with separate deadlines - do not net them.