A qualified retirement plan paying more in distributions than a participant is entitled to occurs frequently. Common reasons for overpayments include miscalculation of benefits due to systemic error, the plan sponsor being unaware of the death of a participant for some time, or the incorrect application of the provision of a plan (e.g., the definition of "compensation"). While unfortunate for participants who received an overpayment, a plan sponsor has an obligation to recover overpayments on behalf of the retirement plan to protect the plan's tax-qualified status and comply with the sponsor's fiduciary responsibilities under ERISA. A recent court case involving the recovery of an overpayment highlights the value of having a robust administrative process for dealing with the inevitable overpayment issues that arise.
Legal Issues with Plan Overpayments
Under both the Internal Revenue Code and ERISA, plan sponsors are not permitted to assign or alienate a participant's benefits to a third party. ERISA provides a fiduciary obligation to recoup overpayments since any overpayment is a plan asset meant to benefit the entire plan. Therefore, a fiduciary has an obligation to attempt, with care, skill, prudence, and diligence under the circumstances, to recover overpayments made from a plan.
Options for Recovering Overpayments for Defined Benefit Plans
Under the IRS' Employee Plans Compliance Resolution System ("EPCRS"), there are four options for correcting an overpayment from a defined benefit plan:
- Participant's return of overpayment in a lump sum, with earnings. This requires the plan sponsor to have the overpayment returned by the recipient to the plan in a lump sum with earnings, calculated at the plan's earnings rate from the date of the distribution until the overpayment is repaid.
- Employer's contribution of overpayment, with earnings. The employer or another third party (e.g., the recordkeeper if, for instance, the overpayment resulted from a recordkeeper error) may contribute the amount of the overpayment, plus earnings, to the plan.
- Participant's return of overpayment by adjusting future payments. In the case of benefits distributed in periodic payments, overpayments may be corrected by adjusting future payments. Of course the risk here is that the participant could pass away prior to full recoupment, which obligates the plan sponsor to repay the remaining amount to the plan.
- Retroactive plan amendment. If the reason for the overpayment is a conflict between plan operation and documentation, a retroactive amendment to the plan's operation may be made in some circumstances.
Options for Recovering Overpayments for Defined Contribution Plans
For a defined contribution plan, the rules are similar. The sponsor must take "reasonable steps" to have the overpayment returned to the plan, with earnings-whether from a participant, the plan sponsor, or another entity. If the overpayment was solely due to no distributable event having occurred, no corrective contribution is required and the participant's account is reduced by the overpayment amount.
The Zirbel Case
The Sixth Circuit Court of Appeals recently decided an issue related to overpayments in Zirbel v. Ford Motor Co., 980 F.3d 520, 522 (6th Cir. 2020). In this case, the dispute centered on an overpayment of nearly $250,000, which constituted an additional ten years' worth of monthly payments. Ford, acting in its capacity as plan administrator, discovered the error four years after the payments were made, and sought repayment, a right specifically provided to it in the plan document. Zirbel appealed to an administrative committee, which denied her appeal but offered her a hardship reduction, which required full disclosure of her finances. Zirbel did not apply.
Zirbel sued Ford, seeking a declaration that she was entitled to keep the money. Ford counterclaimed, seeking restitution of the overpayment. The district court granted summary judgment to Ford.
Zirbel appealed to the Sixth Circuit, which affirmed the decision. The Court of Appeals noted that the plan had a fiduciary duty to recover the amount and also pointed out that the decision to recover the amount was not "arbitrary and capricious." Specifically, the court pointed out that the plan provided several opportunities to appeal the decision, as well as the opportunity to apply for a hardship reduction, which Zirbel rejected. Therefore, nothing about the process "sunk to the level of arbitrariness or [...] capriciousness."
Because overpayments are a frequent problem for plan sponsors, it is wise for sponsors to be prepared for them ahead of time. Like Ford, plan sponsors should consider explicitly providing in the plan document that the plan administrator or other fiduciary has the power to collect overpayments. Although this power has been implied by some courts, the best practice is to be explicit. It also is wise, like Ford, to establish a policy and process for reviewing overpayments and permitting participants and beneficiaries to apply for some level of hardship relief, if appropriate.
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