Correcting an excess contribution for a participant

[Guest Judy S]

In a cross-tested, bells and whistles 401(k) plan for a law firm, 1 participant had about $5,000 too much deposited in her account for the profit sharing contribution for the PYE 1/31/04. The company partially pre-funds the contribution and inadvertently overfunded for her. I advised the employer that they should withdraw the excess contribution on the basis that errors should be corrected when discovered. The participant, however, would like to have the money remain in her account as a credit toward the contribution for the PYE 1/31/05. The participant was a new employee in PYE 1/31/04 and was not highly compensated; she will be highly compensated, however, for PYE 1/31/05. I believe that the company deducted the excess contribution in their FYE 1/31/04, but I'm not positive about that. If it affects the answer, I can find out.

I'd appreciate any opinions on how this should properly be handled. The participant is looking for regulations that require the excess amount to be refunded.

[E as in ERISA]

How about 1.401-1 requires a plan to be a "definite, written program." If you start making contributions/allocations that are outside those definite written terms, then you have a qualification problem.

[Brian Gallagher]

I would say absolutely not, since no one else in the plan would have that option. She would be getting at least a several month jump on potential earnings. Talk about discrimination!

[Appleby]

Isn’t a return of contribution to the employer limited to ‘mistake in fact’ or if the plan is disallowed? Wouldn’t the proper course of action be to put the funds in a suspense account to be allocated the next year to all the employees?

[Blinky the 3-eyed Fish]

The answer as to what to do with the money depends on when it was contributed. If made before 1/31/04 it must be allocated to someone in accordance with the document for the PYE 1/31/04. In this case, it went to this one person erroneously so it should be redistributed as the document allocates the contribution.

But chances are that it was deposited after the plan year end, and in that case you effectively have pre-funded the 1/31/05 contribution. That raises the discrimination issue Brian mentions, so it has to be treated as being deposited to the wrong account and moved. Either to a main account as Appleby mentions or in a manner than is not discriminatory (i.e. only NHCE's or everyone). Of course that last solution could be a problem if there were accrual requirements and the receivers of the contribution ultimately did not meet those requirements.

[Guest Judy S]

Thank you all for your input on this. The contribution was deposited in April or May after the plan year end. I also just learned that they have contributed too much for her in the current plan year also because she is on FMLA leave and will not be entitled to the amount they have already put in for the current year. They have this problem regularly because they pre-fund and also require end of year employment for the contribution. They are aware of the problems this creates, but have passed an IRS audit in which their administration practices were disclosed and so will continue until they have a problem. The overcontribution for last year is clearly a problem and I think I can give the employer a better explanation for why they must correct based on your comments. Thanks again to all.

[Brian Gallagher]

Just as a side note:

Instead of pre-funding the P/S in the EE's account, why not pre-fund a retail account, and liquidate it once a year and make that the P/S contribution?

[Belgarath]

Just tell them, "We generally recommend that you don't pre-fund for the following reasons..., but we love it when you do, because then we get to charge you (x) dollars per hour for cleaning up any problems it creates. It's all up to you. And make sure your Fiduciary liability policy covers a deliberate breach, while you are at it."

I've had remarkable success with this approach. I've finally realized that pleading with a client to protect them from their own unwillingness to listen to those professionals that they have engaged and paid to handle TPA work in the first place, is a losing proposition. On the other hand, when I take a very offhand, matter of fact attitude, and basically say, "but if you choose to ignore this advice, doesn't bother me - it's your problem" I have much better success.

Naturally, I suggest they contact their tax/legal counsel before making any decision one way or the other. Since approximately 99.99998 % of them are too cheap to do that, then mostly they decide to listen.