Don’t Jump the Gun: Why You Should Wait Before Making 401(k) Employer Contributions
Be sure to read to the end for a special trivia question!
Choose wisely when you time your 401(k) contributions
There is something irresistibly satisfying about funding a retirement account early — the same kind of joy you get from clearing your inbox, finishing charting before noon, or finding out your prior authorization actually went through. But when it comes to 401(k) employer contributions, going too early can create a tax mess that is far more painful than waiting until January.
Let’s walk through why timing matters more than you think — and why many physicians and small business owners should hold off on employer contributions until the year is officially over.
1. Employee vs. Employer Contributions: Two Very Different Worlds
A 401(k) plan has two primary contribution buckets:
Employee Contributions (Elective Deferrals)
Up to $23,500 in 2025
Increasing to $24,500 in 2026
Catch-up contributions still apply for those age 50+
The limit applies across all 401(k) and 403(b) plans combined — your main job’s 403(b) and your Solo 401(k) share the same $23,500 cap.
Employer Contributions
These depend on whether you’re a sole proprietor or an S-corp owner.
For Sole Proprietors (Schedule C):
Your allowable employer contribution is limited to the lowest of the following:
20% of net earnings from self-employment, or
Half the difference between your net earnings and your employee contribution
More on these two limits: Link
Clear as mud, isn’t it? Now you know why so many of these have to be fixed every year.
For S-Corp Owners
Employer contributions are 25% of the W-2 wages paid to the owner–employee.
Across both entity types, the combined limit for 2025 (employee + employer) is:
$70,000 for 2025
($77,500 if catch-up eligible.)
2. Overcontributions: The Consequences Depend on Who Contributed
The IRS handles excess contributions very differently depending on whether they came from the employee bucket or the employer bucket.
Employee Overcontributions
If you contribute more than allowed:
The excess can be returned before your tax filing deadline
No penalty if corrected in time
Straightforward fix
Employer Overcontributions
A very different (and much uglier) animal.
Unless the error qualifies under the extremely narrow “mistake of fact” exception:
Employer contributions cannot be removed
The excess triggers a 10% excise tax, reported on Form 5330
The excess must remain in the plan until it is “absorbed” in a future year
Often requires two years of Form 5330 filings
And no — miscalculating your income, using gross instead of net, or plugging the wrong numbers into an online calculator is not a “mistake of fact.”
Once employer contributions go in, they are sticky.
3. Why It’s Safe to Max Employee Contributions During the Year
Because employee contributions can be corrected, you can confidently contribute the full employee limit ($23,500 in 2025) during the year as long as you have the compensation to support it.
If you overshoot:
The custodian returns the excess contribution
You correct your reporting during tax season
No excise taxes, and no long-term issues
Just remember:
(If you are contributing to another employer plan — such as a hospital 403(b) — the $23,500 limit applies across all plans combined.)
4. Why Employer Overcontributions Are a Much Bigger Problem
Accidentally making too large an employer contribution leads to:
An irreversible excess
A 10% excise tax under Form 5330
A reduction in the employer contribution you can make the following year
Potentially two years of additional filings to clean it up
This is why so many sole proprietors and S-corp owners find themselves unexpectedly dealing with Form 5330 — one of the IRS’s least-loved forms.
5. How Employer Contribution Errors Actually Happen
The most common causes:
Using gross receipts rather than net profit
Overestimating income, especially before year-end numbers are finalized
Incorrect calculations, usually due to:
Misreading the worksheets
Forgetting the half-self-employment tax adjustment
Using a calculator that isn’t designed for sole proprietors
For those doing this themselves, I recommend the excellent calculator at Oblivious Investor:
https://obliviousinvestor.com/solo-401k-contribution-calculator/
6. Why Waiting Until After December 31 Reduces Risk
Here’s the central insight:
Employer contributions made in January can be applied to either the prior year or the new year.
Yes, even if your custodian labels your January deposit as “2025.”
The custodian label is a recordkeeping choice — not a legal one. However, you should contact your custodian so that their records are consistent with how you document them on your tax return.
This flexibility means:
If you discover you contributed too much for 2025
You can simply designate the excess contribution for 2026
No Form 5330
No 10% excise tax
But if you contribute too much before December 31, the contribution is locked into that tax year — and if you have already maxed your employee deferral, you can’t reclassify the excess.
That’s how people end up owing penalties.
7. How to Fix an Excess Employer Contribution if It’s Too Late
If the contribution has already been made and can’t be reclassified:
File Form 5330
Calculates a 10% penalty (e.g., $1,000 for a $10,000 excess)
Filed separately from your individual tax return
Leave the excess in the plan
Do not deduct the excess in the year it occurred
Absorb the excess in the following year
Example:
If your eligible 2026 employer contribution is $20,000 and you have a $10,000 excess from 2025, then:$10,000 counts toward absorbing the 2025 excess
$10,000 is a new 2026 employer contribution
File a second Form 5330 in the following year
Documenting that the excess has been corrected
What if you aren’t eligible to make employer contributions the following year?
The excess remains, and the 10% penalty is calculated every year.
The only way out of that predicament is terminating the 401(k) plan.
8. So… Is It Ever Safe to Make Employer Contributions Early?
Sometimes — but proceed with caution.
I generally recommend:
Max out employee contributions first.
Employee contributions are potentially more tax-favorable than employer contributions, since employer contributions can also lower your QBI deduction.Consider IRA (backdoor Roth) and HSA contributions before employer 401(k).
If you have a financial planner, I recommend discussing the optimal order of retirement account funding with him/her. In addition to tax optimization, other considerations come into play, such as flexibility of withdrawals and asset protection.Only make early employer contributions if your compensation is unquestionably adequate.
A sole proprietor with $500k of net profit can clearly max the employer side without risk.When in doubt, err on the side of undercontributing.
Follow the price is right rule. It is truly better to undershoot by $10,000 than exceed the limit by $1.Consult a tax-savvy financial planner or tax pro.
S-corp calculations are straightforward.
Sole proprietors often require a small mountain of worksheets.
The TaxSmart Takeaway
Employee contributions are flexible and reversible. Employer contributions are not.
To protect yourself:
Max out employee deferrals confidently
Delay employer contributions until the year is over
Verify your calculations with a reliable tool or a professional
Avoid excess employer contributions at all costs
When possible, make employer contributions in January so you retain flexibility
A little timing strategy now can prevent a year-long Form 5330 headache later.
Special TaxSmart Trivia Question!
Q: Which of the following best describes the original 401(k) employee contribution limit when plans began in 1981?
A. $23,500 like today
B. $7,000
C. $0 — Congress forgot to set one
D. Whatever your employer felt like that day
Click here for the answer!