Correcting Plan Overpayments

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in California is representative of a common question on overpayments under SECURE Act 2.0.

“A participant in a client’s 401(k) plan accidentally received an overpayment from the plan. What are the new overpayment recovery rules under SECURE Act 2.0?”

Highlights of the discussion

It is not uncommon for an accidental overpayment from a 401(k) plan (or other qualified plan) to a participant to occur. An “overpayment” is 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 or Treasury Regulation).

The struggle is how to correct the plan and recover the overpayment. Generally, ERISA imposes on plan fiduciaries the duty to correct an operational failure (such as an overpayment) by fully restoring the plan to the financial position it would be in if the failure had not occurred. An overpayment is considered such a qualification failure.

Prior to SECURE Act 2.0, a plan fiduciary had three options under the IRS’s Employee Plans Compliance Resolution System (EPCRS): (1) payee returns the overpayment; (2) a make-whole contribution is made by the plan sponsor; or (3) a retroactive plan amendment. Failure for a plan to be corrected under one of these methods could subject the plan fiduciary to a breach of fiduciary duty claim by participants for failing to correct an operational error.

Section 301 of SECURE Act 2.0 gives plan fiduciaries a new option for correcting inadvertent overpayments – the flexibility not to recover the overpayments – and new protections for participants if the plan seeks recovery. Section 301 explicitly grants fiduciaries broad discretion to decide not to recover an inadvertent overpayment without putting them at risk for claims that they have not fulfilled their ERISA responsibilities and maintaining the plan’s tax-favored status. For example, the plan fiduciary could consider any hardship to the participant that would occur if he or she was required to repay an overpayment and the costs to the plan for seeking recovery of the overpayment without putting the plan’s qualification status at risk. Under the new rules, fiduciaries can generally decide not to pursue the recovery of inadvertent overpayments from:

• Participants;

• Any employer sponsoring or contributing to a defined benefit plan, unless the failure to recover the overpayment would materially affect the DB plans’ ability to pay benefits, or a defined contribution plan; and

• Any fiduciary responsible for the overpayment, unless the overpayment resulted from a fiduciary breach.

If the plan does decide to attempt to recover an overpayment, Section 301 imposes new safeguards for participants and beneficiaries. Examples of these new safeguards are limits on recovery amounts (no more than 10% of the overpayment can be recovered each year, or future benefits cannot be reduced below 90% of the amount otherwise payable), a new three year notification and recovery period (a plan administrator cannot seek recovery if the overpayment occurred more than three years before the participant or beneficiary received written notice about the error (except in the case of fraud or misrepresentation); and there can be no recovery of the overpayment from the participant’s spouse or beneficiary.

In addition, under the new safeguards, plan fiduciaries cannot charge interest on the overpayment, including for the period of time when repayments are being made. This is different from previous corrections under EPCRS which permitted interest to be charged. Plan fiduciaries also cannot charge collection costs or other fees associated with recovering the overpayment. The plan fiduciaries also cannot threaten collection actions or litigation unless it has been determined that there is “a reasonable likelihood of success” that the plan will recover more money than the cost of the recovery.

Important for the recipient of an overpayment from a plan is the fact that the overpayment will not be deemed to be an ineligible rollover, and no corrective action will need to be taken by the receiving plan. In addition, if the participant initially rolled the overpayment into a new plan and decides to remove the overpayment and return it to the plan, that amount will be treated as an eligible rollover distribution by both plans.

The new overpayment correction rules took effect on December 29, 2022. We are still waiting for additional guidance on this Section, specifically as to how recovery limits will apply, if at all, to collection efforts if there is no ongoing payment to the participant to offset.

Conclusion

SECURE Act 2.0 gives plan fiduciaries an additional way to rectify plan overpayments: the discretion not to seek recovery of such overpayments. If recovery is sought, however, then the plan must satisfy new safeguards for participants and beneficiaries.