October 15th: The Gift that Keeps on Giving…
As if we didn’t have enough to celebrate on October 15th, the final deadline to attach our financial statement audits to calendar year Form 5500 filings, the IRS issued Notice 2024-77 to provide welcome guidance on inadvertent overpayments.
Oops! I Did It Again, I Paid You Too Much….
In plain English, an inadvertent benefit overpayment (IBO) happens when a participant receives more money than he or she is entitled to under the terms of the plan. More officially, Notice 2024-77 generally defines an inadvertent overpayment as a payment made from a 401(k), 403(b), or DB plan that exceeded the amount payable under the terms of the plan or a limitation provided in the Internal Revenue Code or the related Regulations. For example, if a participant receives a distribution without having met the distribution requirements or an amount greater than the participant’s current vested percentage, the amount exceeding the distribution to which the participant would have been entitled is an inadvertent overpayment.
Let It Be!
The guidance allows employers to let the bygones be bygones by not seeking to recoup overpayments from participants. First, Notice 2024-77 validates that Rev. Proc. 2021-30 states that an attempt to recoup an overpayment from a participant is permitted but not required. Second, the guidance indicates that an individual who receives an inadvertent benefit overpayment and rolls over that overpayment will keep the tax-favored status for the overpayment rollover if a recoupment is not sought. On the other hand, if the employer seeks a recoupment of the inadvertent overpayment, then any amount that is not returned to the plan is not treated as an eligible rollover distribution. Lastly, SECURE 2.0 and section 414(aa) of the Internal Revenue Code, which Notice 2024-77 discusses, indicate that a plan will not be disqualified if the plan fails to obtain payment from a participant, beneficiary, employer, plan sponsor, fiduciary, or other party on account of any inadvertent benefit overpayment. Bottom line, an employer who wants to minimize its correction efforts while maximizing an unexpected benefit to the participant who received an inadvertent overpayment will not seek a recoupment. However, the plan sponsor may have to make a restitution to the plan if the inadvertent overpayment affects the allocations, account balances, or funding attributable to other participants.
If the employer chooses to seek a recoupment, the recoupment request can be combined with the notice that any overpayments not returned are not eligible for tax-free rollover treatment. In those cases, an amended Form 1099-R may be required to indicate that the distribution is not eligible for rollover treatment. The participant can make the repayment in a lump sum, installment payments, or if applicable, a reduction of future periodic distributions. However, disqualified persons are not allowed to make installment payments. If the participant chooses a reduction of future benefits as the repayment method, SECURE 2.0 provides that the amount recouped each calendar year cannot exceed 10% of the full dollar amount of the overpayment.
The bottom line is that if a recoupment is not sought, no notice needs to be given to the participants and the IBO is an eligible rollover. On the other hand, if the employer asks for the money back, a notice must be given to the participant and the IBO is not an eligible rollover. In short, it seems better to let it be, at least in most situations.
If You Don’t Like the Rules, You Can Change Them, If the Change Is Legal
The plan sponsor may also amend the plan to increase benefit payments retroactively for the affected participants in order to adjust for prior inadvertent benefit overpayments, but not if the amendment would cause a violation of a legislative limit or other regulation. Two wrongs don’t make a right.
Overpayments that are a violation of the Internal Revenue Code require a correction in accordance with EPCRS, such as an attempt to recover the funds, and a notice to the participant indicating that the overpayment is not a permissible rollover. This is analogous to returns of excess deferrals, which are not eligible rollover distributions since they represent an amount that exceeded a legislative requirement, not a failure to follow the plan provisions. However, there is no need to correct de minimis overpayments. Revenue Procedure 2021-30 increased the de minimis threshold from $100 to $250. Don’t sweat the little stuff.
The Rules of Engagement
When faced with correcting an inadvertent overpayment, 401(k) and 403(b) plan sponsors have many options:
| Amend the Plan Retroactively | Only if it doesn’t create another violation |
| Attempt to Recoup the Overpayment | Not eligible for rollover if participant doesn’t pay it back |
| Don’t Recoup the Overpayment | Overpayment remains eligible for tax-favored rollover treatment, but the plan sponsor may need to make a corrective contribution to the plan if participant balances or allocations are affected |
The inadvertent overpayment correction options remind me of how little kids play games. Changing the rules as they go along so that they can win–or pretending that they didn’t do something wrong and hoping to get away with it. Except in this case, all the clever strategies are the rules of the game. If plan sponsors mess up, they can change the rules or pretend the mistake didn’t happen. That’s not cheating!
However, SECURE 2.0 permits inadvertent benefit overpayments to remain uncorrected without repercussions to plan qualification or to the participant’s ability to rollover the overpayment to another qualified plan or an IRA, but not if the overpayment is made to a disqualified person. Disqualified persons include fiduciaries, owners of the plan sponsor, their family members, officers, directors, 10% shareholders or partners, sole proprietors and HCEs who earn more than 10% of the total wages of the employer. It means that people with power or influence cannot change the rules for their own benefit. That would be cheating!
Those are the rules of engagement!
