Distribution in Error while still employed

[PainPA]

An employee was termed in April 2009. Was entitled to a safe harbor contirbution for those 4 months. The employer always extends and makes the contribution in September 2010.

The employee takes a 100% distirbution of her account around Dec 2009.

She is rehired in June 2010. (did not know that)

The contirbution is made in September 2010 and John Hancocks system is set to distirbute in the same manner as the previous distribution if you do not let them know in 7 days (not sure of the time frame). The plan sponsor or TPA does not stop it and the money is distirbuted while she was employed (direct deposit to hert account on file with John Hancock).

What are the ramifications of the distirbution?

[Guest SloWorker]

In my opinion, since she was rehired, she is eligible to participate in the plan immediately since she has not accumulated five consecutive breaks of service, so I'm not sure why no one knew she was rehired. As an eligible employee she has the right to refund her account (both distributions) and if she had any forfeitures, get these back. Therefore, even though this was done in error, I would still say she is able to replace the distributions to avoid any tax repercussions, and then have her restored as an active participant.

[PainPA]

just to further clarify...

She doesn't want to put the money back in the plan... she said she "spent it" already...

The plan sponsor knew she was rehired but I was not notified. So when the Profit Sharing was contributed in Sept 2010 for the 2009 plan year it was automatically distributed (in the same manner as the Dec 2009 distribution-taxable) by John Hancock.

My question was since the auto distribution happened when she was still employed, and was not allowed the distirbution, what are the ramifications of the distirbution while still employed.

[Kevin C]

The September distribution when she wasn't eligible to receive it was an operational failure. The EPCRS correction is in Section 6.06(3) of Rev. Proc. 2008-50. They should consider themselves lucky the overpayment did not reduce allocations for other participants.

Rev. Proc. 2008-50, Section 6.06(3) Correction of Overpayment failures. An Overpayment from a defined benefit plan is corrected in accordance with the rules in section 2.04(1) of Appendix B. An Overpayment from a defined contribution plan is corrected in accordance with the Return of Overpayment method set forth in this paragraph. Under this method, the employer takes reasonable steps to have the Overpayment, plus appropriate interest from the date of the distribution to the date of the repayment, returned by the participant or beneficiary to the plan. To the extent the amount returned to a defined contribution plan is less than the Overpayment adjusted for earnings at the plan's earnings rate, then the employer or another person must contribute the difference to the plan. The Overpayment, adjusted for earnings at the plan's earnings rate to the date of the repayment, is to be placed in an unallocated account, as described in section 6.06(2), to be used to reduce employer contributions (other than elective deferrals) in the current year and succeeding year(s) (or if the amount would have been allocated to other eligible employees who were in the plan for the year of the failure if the failure had not occurred, then that amount is reallocated to the other eligible employees in accordance with the plan's allocation formula). In addition, the employer must notify the employee that the Overpayment was not eligible for favorable tax treatment accorded to distributions from Qualified Plans (and, specifically, was not eligible for tax-free rollover).

Don't forget the EPCRS requirement that procedures change to try to prevent this from happening in the future.