Admin Error - contributions withheld after-tax instead of pre-tax

[Guest smstls]

Here's the situation: We recently discovered an administrative error that took place in 2003. An employee's contributions were being deducted on an after-tax basis although he had requested pre-tax. In addition to the negative tax consequences, since after-tax contributions are not matched he lost out on company match money as well. To make this more complicated, he has since withdrawn most of his after tax money so we can not reclassify his after tax contributions as pre-tax.

He has thus far been offered two solutions:

1. He pays back the after-tax money (about $13K) and the plan reclassifies it as pre-tax and he receives the company match. In this scenario he would also be issued a W2-C to correct his 2003 taxes to show less taxable income.

2. Keep things as they are and don't return the money. However, he will not get the company match.

Employee is not agreeable to either solution. He feels that he shouldn't have to take money out of his pocket to correct our error. He wants this issue to be corrected without having to make up the contributions.

Any ideas??

[Guest b2kates]

I would think that you could reclassify without the redeposit and then issue him a 1099 with the early withdrawal penalty.

[Guest smstls]

I thought if you withdraw pre-tax contributions prior to age 59-1/2 for reasons other than an unforeseeable financial hardship it is an operational defect under the plan (and a disqualifying event- unless you correct it)?

[Guest planman]

What was the event that allowed him to withdraw the money? and when did the withdrawal occur?

[JDuns]

Many plans permit the withdrawal of after-tax contributions at any time. I assume from the question that, if the contributions had been classified as pre-tax from day 1, the employee would not have been able to receive the in service distribution (i.e not age 59-1/2 or hardship).

In my opinion you have offered the only two permissible solutions (especially if the employee is an HCE).