Correcting now (or not) for overcontribution in prior year

[Guest SuzieQNEC]

I have recently been assigned to work on a PS plan for a small company. They had a different recordkeeper previously. They allocate the max contribution to the owners.

I have determined that in 2005, they made an error in allocating the contribution to one owner. They intended to allocate the max so he would reach $46,000 (42000 + 4000). They would then reclassify his 401k as catchup. After the client made the deposit, the recordkeeper noticed that the owner did not have any 401k. So they took out the extra 4000 from the contribution and gave it to him as 'other'. The 5500 reported the full deposit as the contribution. Is this allowed somehow?

With a desire not to revise the prior recordkeepers work in 2005, I thought that we could allocate him the full contribution for 2006, and then subtract that 4000 from what is assigned to him. He will be allocated 40,000 (44000 - 4000) in 2006. The plan document says that when there is an overcontribution in error, you can reallocate that amount as forfeiture, so we are then allocating that to the other participants who have not yet reached the maximum limit. Is that an acceptable 'correction'?

Alternatively, would it be acceptable to ignore what the previous recordkeeper did and bring forward his balance and allocate to him the full $44000 for 2006 without taking any other action?

[masteff]

So in 2005, he received $46,000? And the problem is that the $4,000 catchup was improperly recorded as deferrals instead of as catch-up? Sounds to me like a recordkeeping error and all it needs is a recordkeeping correction. Move the $4,000 plus earnings/losses from the improper source to the catch-up source. Note: can't make catchup w/out maxing out normal deferrals, so he should have had money in the 401(k) source if the plan allows deferrals (and he's not restricted from making them as an HCE); multiple sources may be out of whack and need to be reallocated.

[Guest SuzieQNEC]

Thank you for the reply and sorry for the confusion....The prior consultant thought he had 401(k) and intended to transfer $4000 to catchup after maxing out his employer contribution for total annual additions of $46,000. He never made 401(k). Therefore, his total maximum annual additions for 2005 was $42,000. He was overallocated $4000 which was assigned as Other. There is no other source to give it to since there was no 401(k).

[masteff]

Was the last $4000 in this person's account actually deposited in 2005 or in 2006?

[Guest SuzieQNEC]

Yes, the employer contribution was made in 2006.

[masteff]

I tried to think thru scenarios whereby the recordkeeping and 2005 form 5500 could be amended but there would be too many problems.

The most straight forward answer I can think of is: Take $4000 (plus earnings/losses) from the participant to the forfeiture account. This puts the participant in the proper position for 2005. Do 2006 normally. Allocate the forfeitures per the plan document to anyone who doesn't exceed the 2006 limits. (Mostly what you stated above, but not applying the $4000 against his 2006 amount, rather, doing it as two distinct steps.)

P.S. - to your question about doing nothing, just taking the prior recordkeeper's numbers and moving forward... I'd at least give the client written notice about the discovery and let them decide whether to ignore it or to fix it.

[Guest SuzieQNEC]

Thank you for your help on this. It is easy to make adjustments because this is a balance forward plan with only one annual allocation. I have taken your advice about distinct steps and adjusted the overcontribution out at the beginning of the year, so no earnings were ever allocated. Then allocating to him the full 2006 contribution, along with the forfeiture to those still under the limit.