Ineligible earnings put in IRA due to recordkeeping error during 401k

[Guest SusanS]

I rolled from a 401k to an IRA this year. (which have earned nicely since then, mingled with other rollover and IRA funds).

I have just received a note from a "consultant" who is the plan recordkeeper for my old employer that the amounts were about $3,500 too much due to end of year error where that capital gains were double counted, and directly preceeded when I rolled out of the plan. The "consultants" want me to write the current institution and request a return of these monies they no longer have control of.

What are the implications of this error, and what should I do to ensure that this will not haunt me down the road, and what should I expect to happen as a result of this, as I assume that I am indeed obligated to pay back these monies.

[This message has been edited by Dave Baker (edited 05-02-99).]

[Dave Baker]

Ahoy! I edited your message a bit (I'm one of the administrators of the message board) just to delete some hard carriage returns that were making it harder to read.

You probably do have a legal obligation to return the funds. When one party is paid too much money by another, the "common law" generally requires the money to be paid back. (A judge would say "give back the money that doesn't belong to you.") Sometimes the payee gets to keep the money, where the payee has already spent the money or otherwise acted in reliance on the payor's actual or implied representation that the payment amount is correct. Plus you oughta do it. If you don't, the remaining 401(k) plan participants in the plan will have to eat the $3,500, in the form of lower account balances than what they should have been (though maybe the employer or the recordkeeper who made the mistake could fix that by making a supplemental contribution).

You're right to be concerned about having the IRA distribution be reported to you as a taxable distribution. I would tell the plan administrator that you will go along with a correction, but they need to contact your IRA custodian directly and handle the paperwork ... that you'll sign an instrument they prepare at their expense, which gives your OK to the distribution if the terms of the instrument are satisfactory to you, including a provision that the 401(k) plan administrator will hold you harmless from any income taxes or penalties that might be assessed by the IRS against you. Advise the plan administrator of that fact in writing, with a cc to your IRA custodian. I suppose you could also state that you're not going to play ball unless the IRA custodian agrees not to report the payment as a distribution from your IRA account on IRS Form 1099-R (which would cause the IRS to assume it's a taxable distribution to you, I would think).

Anybody else have any further suggestions?

[This message has been edited by Dave Baker (edited 05-02-99).]

[Wessex]

I agree with Dave Baker's comments, especially that you need expert advice and that you should be indemnified for any adverse tax consequences.

It may be in your best interests to respond promptly and have the money transferred back as soon as you are sure that there was an error. Otherwise, it is possible that you could be taxed on the amount of the overpayment under the "claim of right" doctrine, particularly if the matter is not resolved in the same tax year that you received the distribution. Although you can claim a deduction for amounts taxed under the claim of right docrine, it is subject to the 2% floor on miscellaneous deductions (except in the case of amounts over $10,000 for which there is a specific code provision).

Good luck.

[Guest P A Weick]

If you did not get it out of your IRA before your tax return due date for this tax year (4/15/00), you would have an excess contribution subject to a 6% excise tax in addition to being taxable income under the claim of right doctrine. In sum, its best to do the right thing and send the money back once you know how much.

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