Participant paid out before return of excess deferrals

[Guest moorhan]

Can someone tell me in a nutshell what the issues are when an HCE is terminated, withdraws his/her funds from a plan and rolls the funds into an IRA BEFORE excess deferrals for the prior year have been returned. It would seem that some of his/her funds would not be qualified for a rollover into an IRA.

Any suggestions on how one would correct this if at all? What are the problems the plan would face?

Thank you.

[Guest Bud]

I assume that excess deferrals means amounts in excess of the 402(g) limit, not the refund amount necessary for the plan to pass ADP.

Write a letter to the participant and tell him or her to withdraw the amount of the excess deferrals from the IRA. The participant have the bank make a withdrawal without assessing a penalty. The amount of the withdrawal is was not an eligible rollover contribution to the IRA.

If the bank doesn’t go for that, the rollover should unwind and be re-done correctly. That is, move the money back to the plan, the plan distributes the excess, then rolls over the correct amount.

The letter to the participant should also say that his or her 1099-R will reflect the amount that should have been rolled over and the amount the excess deferral. The excess deferral is income and his or her tax return should reflect that.

Excess deferrals that are distributed late are subject to double income taxation. If the excess deferrals were made this year 2001, they are not late. If they were last year 2000, they are already late. The excess deferrals are income in 2000 and the year they are distributed.