Correcting a distribution made in Error

[Guest lbz123]

Here's the situation - an active employee was allowed to receive a total withdrawal of his 401(k) account in error. This was caused because recordkeeper did not update status from terminated back to active when the employee was rehired, although it appears there was direction from employer/plan sponsor to do so. Participant filed distribution paperwork with recordkeeper and since status indicated terminated, the distribution was processed.

Distribution was paid directly to participant, there was no rollover. We are still checking, but this appears to have only happened to just this participant. Based on in-service distribution language in the plan document, the participant could have received most of his account while still employed, so most of the distribution was allowable as an in-service. Only the employee's deferrals shoulld not have been distributed.

I'm unclear on how to fix. Most of what I've seen in regs about this type of thing specifically references hardship withdrawal errors, but I'm applying the same principles because it seems like the closest example I can find.

Does anyone know if this can be corrected under SCP, or do we have to go the VCP route? I've reviewed both IRS SCP and VCP regs, and I'm unclear. Distribution occurred last year, we would be fixing it now. It appears that only 1 participant out of a plan that covers about 2300 has had this type of error (we are still checking), and the impermissible portion of the distribution was only about $5000 (an insignificant percentage of the overall assets).

For correction, we will ask participant to repay that portion of the distribution which he should not have received. However, I am certain this employee will NOT repay the amount. It appears that if the participant refuses repayment, the employer would need to make the repayment. But would the repayment be made to the particpant's account, creating a windfall for that participant? It doesn't seem right the employee should end up financially ahead in this type of scenario.

Or would employer make repayment to the Plan - to a forfeiture account within the plan for example? Since plan doc allows for forfeitures to reduce future company contributions funding, that doesn't seem to make much sense either. The company could make the repayment to the Plan, and then immediately use those same monies now in the forfeiture account to reduce that week's wire transfer for company contribs. It seems to make the repayment option pointless, however, I suppose if your plan doc didn't have this wording, the monies would be in forfietures and have to stay there.

And in any repayment scenarios, should the repayment have an earnings calucaltion worked into it to cover the period from the impermissible distribution to the date of repayment?

Appreciate any help that can be provided.