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So, my ex-employer from 5+ years ago just sent me a letter asking for the return of $6400 that it says was distributed from my old 401K plan, in a nutshell that the amount wasn't vested.

I left in 2015, and officially rolled over my 401K balances/funds into a Rollover IRA in 2018.  

This is official text of letter...

Quote

"...we discovered you have an overpayment from your account in the XXX 401K Plan....we determined the vested amount in your 401K plan account was overstated when we processed your distribution request.  As a result the overpayment is not eligible to be distributed because it is not vested"

"The overpayment is $6426.10 and must be returned to the plan excluding any additional interest"

"In addition the Plan must notify you that the overpayment amount was not an eligible rollover distribution if your distribution was rolled over into a qualified retirement plan or IRA...you may request that the plan administrator or your IRA trustee transfer the overpayment funds back to the plan"

"You will receive updated 1099's for the original tax year of the overpayment by the end of November"

Soo...questions.  What should I do with this?  I figure that at the very least I'm going to owe the IRS an early distribution penalty on that $6400?  But isn't that admitting that I made a mistake in fact when this was the error of the 401K plan?  Do I need to pay back this amount?  Any advice is appreciated   Thank You

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What you should do is talk to them.   They do owe you some explanation of how the amount was computed.  There is an excellent chance you owe the funds and you have funds in your IRA that shouldn't be there.  

You should also ask them for help in getting the money transferred from the IRA to the plan that doesn't generate a 1099-R from the IRA.  You shouldn't be taxed or have to pay any kind of penalty for giving back money.  If you don't get to keep the money why should you pay taxes on it?  

While the fact they made a mistake doesn't relieve you of the duty to pay back the money it does put some burden on them to help you make the correction as painless as possible.

So start with communication.  

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Write them a letter asking them to indemnify you for any  services you require with respect to this transaction and reimbursing you for any fines or excise taxes the IRS may impose due to their error in over paying you.

Also ask for a full accounting of how they arrived at the figure in question.

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Thank you ESOP guy and Lou.  Is there any danger here in just waiting until they send out a second letter/request to see if they are actually going to try and collect this money from me?  

I'm not a lawyer or an accountant but it would seem the tradeoff is A) pay back the $6400 and have them assume costs associated with any penalties or B) ignore and hope they don't try to collect, yet still face the costs associated with the taxes/early withdrawal fee related to the $6400 in question) which would probably equate to somewhere around $2000 or so I guess roughly speaking.

 

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If it really was a mistake and you do owe the Plan the funds, ask them to assist you with coordinating with your IRA company in reversing the $6,400 back to the plan as a non-taxable trustee to trustee transfer. As for ignoring the letter, that's legal advice above my pay grade but it is possible they may determine it's not worth trying to get the $6,400 back from you if they have to go to court.

 

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This is NOT legal advice.  In my 40 years in this business, much of it in the employment of large insurance company vendors, I have never seen an employee in this situation pay back the money.

If you wish to continue to engage with this, I think Lou S. and ESOP Guy have given you excellent advice.

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I will point out that if (and that is a big if) the IRS were to find out that those funds are in the IRA and there still in there that could be subject to an excise tax every year until the money is taken out.  Depending on the new 1099-R they send out that might tip the IRS off.  

I have seen the money sent back but it is rare for the obvious reason.   The cost of a lawyer to get you to give the money back if it comes to push vs shove will add up to the amount they over paid you pretty quickly.

So it does come down mostly to what is your ethics in this situation.  

I stand by my earlier recommendation in that regard- go talk to them.  There is a good chance it isn't your money but someone else's money you have in the IRA.  

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1 hour ago, ESOP Guy said:

I will point out that if (and that is a big if) the IRS were to find out that those funds are in the IRA and there still in there that could be subject to an excise tax every year until the money is taken out.  Depending on the new 1099-R they send out that might tip the IRS off.  

I have seen the money sent back but it is rare for the obvious reason.   The cost of a lawyer to get you to give the money back if it comes to push vs shove will add up to the amount they over paid you pretty quickly.

So it does come down mostly to what is your ethics in this situation.  

I stand by my earlier recommendation in that regard- go talk to them.  There is a good chance it isn't your money but someone else's money you have in the IRA.  

Sorry i mispoke, the letter only said 1099, not 1099-R but not sure if that matters.  They did say they would send the updated 1099 or the original tax year of the overpayment.  Thus, if I don't return funds then I am definitely on the hook for the taxes and the early withdrawal penalty, right?

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Does this sound ok?

 

To Whom It May Concern:
This letter is in reference to a recent notice I received regarding a supposed overpayment from my former 401K with XX.  This letter confirms that I have received your communication.

I am requesting that XX provide me a full accounting and evidence of how they arrived at the figure in question.  I am also requesting that XX provide 401k statements from the length of my employment from 2013 through 2015, along with an employee handbook and/or 401K plan document from the time of my employment that provides the details surrounding the vesting schedule for the 401K plan. 

I am requesting that XX also provide a letter signed by an officer which will legally obligate XX to indemnify me for any services required with respect to this transaction (including but not limited to accounting and legal fees) and reimbursing me for any fines or excise taxes (i.e., any taxes) the IRS (or my state - Massachusetts) may impose due to XX error in over paying me.  

In addition, I would also like to note that it is nearly impossible to determine whether the amount distributed to me  shrunk or grew over years.  How is it possible, that five years following my departure from XX, you find that I personally should be liable for your errors?  And in the midst of a pandemic, nonetheless?   I am now required to spend countless hours of my time and effort to try and remediate an error made by your company within a month of time?  This is not fair. 

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You are asking for a lot.  I don't know if you will get it all.  

 

As for your other question it depends some.  You have money that isn't eligible to be rolled into an IRA.  Depending how the new 1099-R reads it might make that clear to the IRS.  I would focus on getting a decent accounting of why and how much you really owe and help to get the money transferred out of the IRA back to the plan that doesn't cause you to owe any taxes on the distribution.  

 

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So, just got a follow up letter to the original...note not a response to my letter that I sent to them, but another automatically generated letter looking for the money.

In this letter they extended the expiration date for when payment is needed to October 30, 2020.

"A previous request was made for the return of the overpaid amount, without resolution. We ask you respond prior to October 30, 2020 so that we may correct the 1099 tax document details before the end of the year."

Note I did get access to my old 401K statements and it appears that at the end of 2017, I was only 67% vested in the contributions matched by my employer, thus since I received payment on Jan 8, 2018, it seems like the are probably correct. One other note, the distribution was made via check from my previous employer to Fidelity.

Now what should I do?

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So just an update here. I did not hear back from my former employer or their plan admin.

But I did get a letter from Fidelity asking me to sign a form confirming a distribution from my IRA.

Apparently the legal department from the plan administrator sent letters to Fidelity which they included in the mailing to me.

It says:

"Due to incorrect vesting credit that occurred with respect to XXX 401K Plan the payment included funds that were not owed or due to the individual in the amount of $6426.10. That payment was directly rolled over to the account noted above. This amount is required to be returned to the Plan. We have already notified the individual in a separate letter. Accordingly we hereby instruct Fidelity Investments to remove the ineligible amount of $6426.10 from XX account and return it to the plan as follows:

"XXX will indemnify and save Fidelity Investments its parents, subsidiaries, affiliates.....blah blah blah from and against all claims liabilities, damages, actions, charges and expenses sustained or incurred as a results of its instruction to Fidelity to return the overpayment described above."

Note they are offering to indemnify Fidelity but has not sent me anything in regards to any taxes, fees or penalties I will incur.

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If Fidelity does a direct transfer back to the plan there shouldn't be any taxes or penalties from the IRS.  

What you really want to make sure is Fidelity does a transfer that doesn't generate a 1099-R to you more than anything else.  

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thanks for the response.  i thought there was a 6% annual excise tax on excess contributions?  and what about on the earnings for the two years? 

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