The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with a financial advisor in Massachusetts is representative of a common question related to overpayments to DC plan participants. The advisor asked:
“My client’s company processed an in-service payment to her from her 401(k) plan. The payment exceeded the amount to which she was entitled. The plan is asking her to pay the amount of the overage back to the plan. What is the proper way to correct this error?”
Highlights of Discussion
- Paying the overage back to the plan may be part of the correction process, depending on which IRS correction method the plan sponsor chooses to follow.
- The IRS categorizes a payment made to a participant or beneficiary that exceeds the amount payable to the individual under the terms of the plan — or that exceeds an Internal Revenue Code (IRC) or Treasury Regulation — as an overpayment, and a potential plan qualification error for operationally failing to follow the terms of the plan. An overpayment is correctable under the IRS’s Employee Plans Compliance Resolution System (EPCRS).
- Applicable on or after March 27, 2015, the IRS expanded the overpayment correction options available through EPCRS. The new rules are found in IRS Revenue Procedure (Rev. Proc.) 2015-27, which modifies Rev. Proc. 2013-12 regarding the EPCRS.
- Generally, there are three methods that a plan sponsor can follow to correct an overpayment:
— Return of overpayment: The employer must take reasonable steps to ensure that the payee returns the overpayment to the plan, adjusted for earnings at the plan’s earnings rate from the date of the distribution to the date of repayment. The plan sponsor must also notify the payee that the overpayment was not eligible for favorable tax treatment and, specifically, was not eligible for tax-free rollover. No correction is required if the overpayment is $100 or less.
— Make-whole contribution: The plan sponsor or another responsible entity contributes the amount of the overpayment (with appropriate interest) to the plan in lieu of recouping the amount from plan participants and beneficiaries.
— Retroactive plan amendment: The plan sponsor adopts a retroactive plan amendment to conform the plan document to the plan’s operations.
- The most appropriate correction method depends on the facts and circumstances surrounding the overpayment.
- The IRS invited public comments through July 20, 2015 on the overpayment correction methods as outlined in Rev. Proc. 2015-27 and 2013-12.
EXAMPLE: Method 3, retroactive plan amendment
Going Retro, Inc., a for-profit corporation, maintains a 401(k) plan. Although plan provisions in 2013 did not provide for hardship distributions, operationally, beginning in 2013, the plan made hardship distributions available to all employees. The plan processed hardship distributions for a number of employees during the 2013 and 2014 plan years, creating an operational failure. The plan sponsor discovered the error in 2015. Going Retro corrects the failure under the Voluntary Compliance Resolution (VCR) program of the EPCRS by adopting a plan amendment in 2015, effective Jan. 1, 2013, providing a hardship distribution option to all employees.
Conclusion
Today, plan sponsors have more correction methods available for fixing plan overpayments than ever before. The key to righting the plan is early detection of the issue and following the provisions of the IRS’s EPCRS. Watch for additional clarification that may come as a result of the public comment process.
The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.
Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.
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