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Impermissible distributions taken from ERISA 403(b) plan


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This may not be that uncommon, but I can't say I've seen it.

403(b) plan has custodial accounts only - not annuities. Plan provides for hardship distributions on deferrals. So far, so good. However, the employer allowed hardship distributions from employer contributions, as well, and disn't restrict it as they were told to do.

This happened on 5 out of 60 or 70 participants. There's no allowable SCP correction by amendment on this, as there might ordinarily be on hardship issues, because the plan can't provide for hardship withdrawals on employer contributions in the custodial accounts. So, this is an overpayment that would need to be corrected under Section 6.06(4) of Revenue Procedure 2013-12. This means the employer must take "reasonable steps" to have the overpayment

returned, with interest. Well, since these were hardship, chances of getting it returned are about nil. In this situation, there's no requirement for the employer to "make up" any overpayment that isn't returned.

So here's my question - it seems like the only "piece" of the correction that still applies is the notification to participants that this wasn't an eligible rollover distribution. Well, they already know that - they were informed at the time that they took the distribution that it would be subject to 10% penalty tax if they didn't meet one of the other exceptions. So really, what is the actual correction here? I can't see what it might be, other than to "NOT DO IT ANY MORE."

Is there any actual correction that can be done, other than a basic letter attempting to recover the impermissible distribution plus interest? And when that doesn't happen, end of story? Anyone had any experience, or audit experience on such a situation?

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Based on nothing more than gut reaction I think you're correction is more than just a don't do it again notice.

Had a somewhat analagous situation where MPP plan allowed in-service "hardship" withdrawals and IRS is requiring the plan sponsor to restore the $$ to the plan (since the employees have already spent it of course).

Since you have a violation of what I'll call a qualification requirement I think the plan sponsor has to restore the accounts.

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Thanks for the responses.

Flyboy - the Revenue Procedure specifically states that the "make-up" employer contribution doesn't apply in this circumstance. See Section 6.06(4)(b). Hence my question as to how extensive the actual correction will be.

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6.06(4)(b) says get the overpayment back from the participant. If that doesn't work the employer makes the plan whole unless the erroneous distribution was due to "the absence of a distributable event (e.g. an impermissable in-service distribution)".

I suspect we may disagree with the scope of the exception to the general rule that the employer must make the plan whole. I read "absence of a distributable event" narrowly to apply to situations where the distribution would have been "permissable by law" but was impermissable under the terms of the plan. Examples might be making a hardship distribution from a money-type not authorized by the plan document or for a reason not recognized by the plan's hardship policy.

Under my narrow reading any overpayment "impermissable by law" would not qualify for the exception since a distribution was made that couldn't have been legal no matter what the plan document said. Examples would be in-service distributions from a money purchase plan, hardship distribution of earnings on elective deferrals or, as in your case, hardship distributions of employer money from a 403b custodial account.

Certainly would be nice if the IRS would clarify just how expansively we can read the term "absence of a distributable event".

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Thank you for your thoughts on this. Yes, we'll agree to disagree. I interpret the section in conjunction with the definition of Overpayment in Section 5.02(4), which states that "Overpayments include both payments either made from the participant's or beneficiary's 403(b) custodial account or annuity contract under the plan or not permitted to be paid under the Code, the regulations, or the terms of the plan." (My emphasis)

I think this approach also may make more sense (although when does that matter) in that otherwise, if the employer is unsuccessful at recovering the money (as is likely in a hardship situation) the employee receives a windfall. I'm dubious that this would be an intended result of the correction program in this situation.

So, I'll stick with saying the Employer doesn't have to make up the payment if "reasonable" efforts don't succeed, but I very much appreciate your comments.

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Thanks for continuing the discussion and sharing your point of view.

Do you mind providing an example or 2 or where the employer-make-whole rule WOULD apply?

Still can't get my arms around the position that a plan can violate the law and get away with just asking the participant to return the $$.

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Example: Terminated Employee's account is worth $10,000, the Trustee sends him a check for $12,000.

Example: ADP refund is 600, person is paid 900.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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Thanks, so playing devil's advocate if I have a doctor/plan sponsor/trustee who against my advice takes an in-service distribution of elective deferrals prior to 59 1/2 or an in-service distribution of money purchase pension plan $$ it could be "fixed" by asking himself to repay it and possibly needing to make a VCP filing?

Seems like too light a sanction for a serious violation of law.

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