How to Remove Excess Charles Schwab 401(k) or SEP Contributions

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The truth is that retirement contribution mistakes happen. Even the IRS and Charles Schwab acknowledge this. In fact, the IRS has issued guidance on this under their self correction program. You can find out more about this here.

So even if you’ve made a mistake and overfunded your 401(k) or SEP-IRA you have the ability to correct it. But there are some rules that you will need to follow.

The purpose of this post is to give you some insight on how to correct 401k and SEP overfunding errors at Charles Schwab. The goal is to get it resolved so you can be compliant. Let’s discuss some of the basics and then we can dive in to the mechanics.

Contribution Rules

Let’s take a quick look at the contribution rules. You can combine cash balance plans or defined benefit plans with 401(k)s and many SEP-IRAs. But there are rules and restrictions when combined. 401(k) employee deferrals are fine with no restrictions. But the profit-sharing component of a 401(k) is limited to 6% versus the standard 25%.

It is fairly common that people will fund a defined benefit plan and then also contribute 25% to the 401(k) profit-sharing component. There are ways around this limitation. But practically speaking, it is just not possible (or practical) for most people. The reality is you’ll need to contact Charles Schwab to correct this error.

Even though Schwab has always been a relatively easy custodian to deal with, some of their phone reps just don’t understand the specifics. We deal with a specific rep there who can assist with the paperwork. His name is Matt Gilbert and his phone number is. He is a great resource and can get you the forms that you need to get the funds reversed.

Removing Excess Schwab SEP-IRA Contributions

When it comes to combining a SEP-IRA and a cash balance or defined benefit plan, the rules are a little tricky. The IRS does not allow a cash balance plan or defined benefit plan to be combined with what is called a model SEP. A model SEP was one that was established using IRS form 5305. The IRS rules specifically state that if you’ve establish it under this plan it cannot be combined. If you made this mistake, your only option is to remove the entire contribution.

However, you can still keep the plan open and maintain any account balance. You just won’t be able to contribute to it while you are operating a defined benefit plan.

But let’s assume that you have a non-model SEP and made a 25% contribution. The excess portion over the 6% would have to be removed.

For example, let’s assume that you have an S-Corp and have a wage of $150,000. You accidentally contributed 25% to the SEP and also made a $100,000 contribution to a defined benefit plan. The numbers would look like the following:

  • SEP Contribution = $37,500 (25% of W2)
  • Defined benefit plan contribution = $100,000
  • Total retirement contribution = $137,500

As you can see, the SEP was overfunded and the excess must be removed. Here is the calculation of the excess:

  • Allowable contribution = $9,000 (6% of the W2)
  • Excess contribution = $26,500 ($37,5000 minus the $9,000)

Removing Excess Schwab 401k Contribution

But many custodians have set up their custom separate plans that have been approved by the IRS. As long as you use one of these set plans you can combine them with a cash balance or defined benefit plan. However you are still limited to the 6% contribution. In practice, the majority of people that we work with do not combine ASAP with a defined benefit plan. The main reason is that people want to have the ability to maximize their plans in a sept does not allow an employee deferral. This being the case people are losing the $19,500 or $26,000 referral and leaving it on the table. It just does not make a lot of sense when you are looking to maximize contributions.

Paul Sundin

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