Is ChatGPT sufficiently reliable to provide advice on employee benefits matters? Not yet, but ChatGPT and generative Artificial Intelligence may likely be useful tools for employee benefits attorneys in the future.[1]
As it is late March, we asked ChatGPT 3.5 to solve a common issue: an individual made deferrals above the Internal Revenue Code § 402(g) limit (although typically these are referred to as “excess deferrals,” in the ChatGPT 3.5 reply it uses both “excess contribution” or “excess deferral” interchangeably. In the Faegre comments, we use the term “excess deferral.”). As background, the Internal Revenue Code limits the amount of employee deferrals that can be made within a participant’s taxable year (almost always the calendar year). In 2023, that limit was $22,500. An individual who participates in more than one 401(k)/403(b) plan is responsible for monitoring whether they exceed the limit with respect to all plans in which the individual participates.
We asked ChatGPT 3.5 the following question: “How do you correct a Code Section 402(g) limit failure?” The italicized language below is the exact answer from ChatGPT 3.5, except that the footnotes are our commentary on the response (note the formatting was all done by ChatGPT 3.5):
Code Section 402(g) sets the annual limit on elective deferrals that an individual can contribute to their retirement accounts, such as a 401(k) plan or a 403(b) plan. If you exceed this limit, it’s important to take corrective action promptly to avoid potential tax penalties. Here’s how you can correct a Code Section 402(g) limit failure:
- Identify the Over-Contribution: Determine the amount by which you exceeded the annual limit for elective deferrals under Code Section 402(g). For 2023, the limit was $19,500 for individuals under the age of 50, and $26,000 for individuals age 50 and older. 1
- Contact Plan Administrator: Notify the administrator of your retirement plan about the excess contribution as soon as possible. They can assist you in taking the necessary steps to correct the error.2
- Request Distribution or Refund: You can request a distribution or refund of the excess contribution amount from the plan. This typically involves filling out a specific form provided by the plan administrator. The excess amount, along with any earnings attributable to it, must be removed from the plan by the deadline specified by the IRS to avoid penalties.3
- Correct Before Deadline: Ensure that the excess contribution, along with any earnings, is removed from the plan no later than the applicable deadline. The deadline for correcting excess deferrals typically falls within the first two and a half months of the following tax year. For example, excess deferrals for the 2023 tax year must be corrected by March 15, 2024, or the business day preceding March 15 if it falls on a weekend or holiday.4
- Report Corrective Distribution: Report the corrective distribution on your tax return for the year in which the excess contribution occurred. You may need to include IRS Form 1099-R to report the distribution, and you may also need to file IRS Form 5329 to calculate any applicable additional taxes or penalties.5
- Adjust Future Contributions: Review your contribution elections to ensure that you do not exceed the annual limit for elective deferrals in future years. You may need to adjust your contribution amounts to avoid exceeding the limit again.
- Consider Alternative Correction Methods: Depending on your specific situation, you may have alternative options for correcting excess deferrals, such as utilizing catch-up contributions if you are eligible or making corrective distributions in the following tax year. Consult with a tax advisor or financial planner to determine the best course of action for your circumstances.
It’s essential to act promptly and follow the correct procedures to correct a Code Section 402(g) limit failure to avoid potential tax consequences and penalties. If you’re unsure about how to proceed, consider seeking assistance from a qualified tax professional or financial advisor.6
Faegre Drinker’s Footnotes:
- This is wrong, the 2023 Code Section 402(g) limit was $22,500 (and $30,000 after catch-up contributions for individuals age 50 and older). The $19,500/$26,000 limits were for calendar years 2020 and 2021.
- Correct.
- The amounts need to be distributed to avoid double income taxation, not necessarily a tax penalty. The failure to remove the excess deferrals by April 15 results in taxation of the deferral in the year contributed and again in the year distributed from the plan.
- Under the Internal Revenue Code, the excess deferrals must be distributed by April 15, not March 15. See Treasury Regulation § 1.402(g)-1(e)(2)(i). (The two-and-a-half-month deadline applies to distribution of excess contributions due to 401(k) ADP test failure.) But note, some plans may require a request for an excess deferral distribution prior to April 15 and participants would have to comply with the plan’s deadline.
- This sentence is not as clear as it could be. An individual’s tax return for the year in which the excess deferral occurred needs to reflect the excess deferral and potential correction. If the excess deferral with respect to 2023 is distributed prior to April 15, 2024, then there would be two IRS Form 1099-Rs issued by the plan for the year 2024 (issued in January 2025). The excess deferral amount is reported on one Form 1099-R as Code P (taxable in a prior year, 2023) and the earnings on the excess deferrals are reported on another Form 1099-R in Box 8 (and taxable in 2024). IRS Form 5329 does not apply to excess deferral corrections because the 10% early distribution tax does not apply to 402(g) corrections if done prior to April 15. In addition, the response does not address the difference between pre-tax versus Roth contributions. But to be fair, we did not ask ChatGPT 3.5 about Roth contribution 402(g) limit corrections.
- Or legal counsel!
As you can see from the above, ChatGPT 3.5 did a good job summarizing the issue, formatting an easy-to-read response, and providing generally accurate guidance on the correction. It even included a note that the individual should contact a tax professional. The guidance was not exactly correct nor did it necessarily provide information a plan sponsor would need to fully implement a correction. A plan sponsor would likely have questions that were not answered by ChatGPT 3.5 in its initial response, although subsequent questions could have been posed.
ChatGPT 3.5 and other generative AI will not replace your ERISA counsel anytime soon, but it is a tool that your ERISA counsel and other advisors may be able to use to assist clients more efficiently in the future. If you have any questions (402(g), AI or otherwise), please reach out to your Faegre Drinker benefits counsel.
[1] This post does not discuss other considerations for the use of ChatGPT or similar generative AI products, including ethical use and data protection considerations. These considerations must be explored and satisfied before attorneys deploy use of ChatGPT or similar generative AI products.
The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.
