Retirement plan administration mistakes require difficult conversations with participants, especially when the mistake involves an overpayment. Changes in the law, specifically, SECURE 2.0 and IRS Notice 2024-77, give plan fiduciaries additional flexibility when addressing overpayments.
Overpayment of Matching Contributions
Consider the case of a 401(k) plan with an employer matching contribution on the first 6% of compensation that a participant contributes to the plan. The plan sponsor adds a Roth after-tax deferral feature to the plan and confirms that the match formula applies to Roth deferrals. Unknown to the plan sponsor, the payroll program applies the 6% compensation limit separately to traditional pre-tax deferrals and to Roth deferrals, resulting in a maximum match on 12% of compensation if the participant elected a 6% pre-tax deferral and a 6% Roth deferral. In the course of correcting the error, the plan administrator determines that some affected participants terminated employment and received a lump-sum distribution of their account balance that included the excess matching contributions.
Correction Process Prior to SECURE 2.0
Prior to SECURE 2.0 and IRS Notice 2024-77, the plan administrator was required to take steps to recoup any overpayment that exceeded a small amount ($250) or risk disqualification of the plan. Such steps included sending a notice to the former participant requesting that the excess match be returned to the plan, advising the former participant that the excess matching contribution was not eligible for rollover, and issuing a revised Form 1099-R showing the overpayment amount as not eligible for rollover. If the excess match was rolled into an IRA, the former participant would owe a 6% excise tax on the amount of the overpayment for each year that it remained in the IRA. If the overpayment of excess match was not returned to the plan, the plan sponsor was required to contribute to the plan an amount equal to the overpayment.
After SECURE 2.0
New Code Sections 414(aa) and 402(c)(12), added by SECURE 2.0, have streamlined the correction process under the Employee Plans Compliance Resolution System (found at Rev. Proc. 2021-30) in the event of an inadvertent overpayment. Specifically, Code Section 414(aa) relieves a plan from potential disqualification if the plan fiduciary fails to obtain repayment from any participant or other party on account of any inadvertent benefit overpayment by a plan. Any overpayment that involves a violation of the annual compensation limit (Code Section 401(a)(17)) or the annual maximum contribution limit (Code Section 415) is excluded from the new rules. Code Section 402(c)(12) provides that any inadvertent overpayment under Code Section 414(aa) will be treated as an eligible rollover distribution. If the plan requests repayment of the inadvertent overpayment, then any amount returned to the plan will be treated as an eligible rollover distribution.
In Notice 2024-77, the IRS defines the term "inadvertent benefit overpayment" and describes how Code Sections 414(aa) and 402(c)(12) modify Rev. Proc. 2021-30. To qualify for the new rules, the plan sponsor must have established practices and procedures that satisfy the standards set forth in Section 4.04 of Rev. Proc. 2021-30, and the error must not be egregious.
Notice 2024-77 provides that a plan fiduciary of a defined contribution plan, such as the 401(k) plan in the example above, is not required to request repayment of excess matching contributions that were distributed to terminated participants, even if the excess amount exceeds $250. If the fiduciary does not request repayment, then the excess match is an eligible rollover distribution. If the plan fiduciary requests repayment of the excess amount and repayment is not made, then the excess payment is not treated as an eligible rollover distribution. In addition, the 401(k) plan sponsor in the above example is not required to make a corrective contribution for the excess match that is not returned to the plan.
Notice 2024-77 also modified the rules in Rev. Proc. 2021-30 for recouping inadvertent benefit payments made by a defined benefit plan. If you have questions about those rules, reach out to the author or any member of Dickinson Wright's Employee Benefits and Executive Compensation team.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
