Overpayment to terminated participant

[Guest Thom Shumosic,CFP]

I have a sticky situation that needs some insight.

A 401(k) plan that my firm advises recently changed third party administrators. When the new TPA reviewed last years activities, it was discovered that a terminated EE received approx. $10,000 too much. It was also found to be a human error by the former TPA.

The clients point is that the TPA needs to put the money back in the plan and if they choose to attempt to recover, it's on the former TPA. The former TPA is balking, claiming the plan sponsor needs to recover the money.

Anyone with advice or experience?

[Alf]

The fiduciaries have a legal obligation to try and get the money back into the plan from someone. You will have to hit the ASA hard to see who is legally responsible, although the TPA has to know that they aren't going to get sued over 10,000. You also have a disqualification risk, because the terms of the plan document weren't followed, so you will have to make sure that you follow EPCRS.

[KJohnson]

I agree that TPA's E&O insurance may be the way to go.

You might "ask" the participant for the money back first. Technically if they were not entitled to the total distribution they could not roll that amount raising excise tax issues etc.

If it is the TPA's mistake tell them that if they don't pay they will then need to reimburse plan for the attorneys fees spent going after the participant. They would then be facing more than $10,000 with no sure bet on recovery. Actions against participants for overpayments are "equitable" in nature and participants will have various defenses.

[Guest]

I have had experience with your exact situation, but not quite at that dollar amount. When I worked for a major insurance company we had valued one of our mutual fund accounts incorrectly and did not find the error for over 3 months. We had paid out around 50 participants during that time frame and some were overpaid. We did not attempt to go to the participant to get the money, nor did we ask the plan sponsor to do that. We, as the insurance company, made the plan whole. We also had some participants who did not receive enough money(there was more than one fund involved) and we paid them the additional dollars due to them.

I believe the bottom line is the plan needs to be made whole. I think it would be difficult to recover the money from the participant. Doesn't the DOL look unfavorably on a situation where an attempt is made to "take away" money that was allocated to a participant? The former TPA should do the responsible thing and put the money into the plan; however, the fiduciary is the one that is ultimately responsible for making the plan whole. The TPA's E&O insurance should cover this type of error. The Plan Sponsor might want to try and recover through that route and then if that doesn't work, they may have no choice but to sue the former TPA.

[Earl]

hardballing the terminee who received the extra money was the option a client of mine took. Threat of amended 1099 creating excess IRA contributions and excise tax. The guy actually gave the money back.

This was a case where the mutual fund company mailed the distribution to the participant (payable to the Trustee, fbo the Participant). Partic. had elected direct distribution and his bank cashed the check. We thought that the bank might be responsible in some way because we also had a failure to withhold income tax issue.

Former Participant came up with the money and problem ended.

[Guest Jensen14]

My experience has been that the TPA has made the Plan whole because of their error.

The TPA's insurance takes care of these types of errors.

Going after the old ppt usually proves to be a difficult process. There is no way to know how they will react when threatened or asked to give back the money.

[Earl]

do you think it is a fiduciary duty to formally request?

do you think the bank or mutual fund company is liable in my example?

[KJohnson]

I know in various VCR corrections, the IRS has always required that you tell the participant that the excess amount is not elligible for rollover. You probably sent the standard "tax notice" as well as a subsequent 1099 indicating the P could roll the amount. You may have a duty to correct this. As long as the Plan is made "whole" I do not think your duty goes any further from a fiduciary aspect.

[Guest]

Earl, I think you raise an interesting question about the fiduciary responsibility. I think it makes sense to make a formal request to give notice to the participant that the money was sent to them in error and that the plan is willing to work with them in whatever way possible to recover the money...such is putting together some type of payment plan. If the participant does not respond favorably, then at least an attempt was made and can be documented as such.

In your example, the bank should probably not have cashed the check. I don't think the mutual fund would have any liability unless they mailed the check to the wrong entity. But, my experience with most banks is good luck in collecting anything from them!

[david rigby]

Interesting follow-up to this issue:

http://www.benefitslink.com/cgi-bin/qa.cgi...qa_plan_defects

[Kirk Maldonado]

I disagree (slightly) with Earl. It is not a "hardball" technique to tell the former employee that you will issue an amended 1099-R if they don't repay the "excess" amounts. I think that the plan is legally obligated to do so.

[david rigby]

I agree with the comment by Kirk.

[Guest mo]

Having had the pleasure of being involved in several of these situations, my experience is that generally speaking, the E & O insurer will not pay the claim unless recovery has been attempted.

[pjkoehler]

Thom, you may want to review a thread on this same subject that started under "Correction of Plan Defects" on 5/12/00. As a practical matter, the TPA probably shouldn't make any direct deposits into the plan. It could of course reimburse the employer for its corrective contribution.

As a financial accounting matter, since the participant owes the plan the amount of the benefit overpayment, the plan should regard the overpayment as an asset ("overpayment receivable"), until it concludes that all reasonable efforts at recovery have been exhausted. At that point the fiduciary responsible for the payment would be liable to makeup the loss to the plan. Since the TPA will probably take the position that it is merely a nonfiduciary contract agent of the employer and the employer appears to want to take the position that it delegated its fiduciary responsibility to the TPA (or that the TPA became a plan fiduciary throught its own actions), this step is likely to get messy. In my experience, most employers blindly sign a standard form TPA agreement that is emblazoned with "We are not a fiduciary" window-dressing from start to finish. So it will be a hard (translated: expensive) row to hoe from a litigation standpoint.

Of course, the employer could make up the loss even if it isn't the responsible fiduciary and pursue a collection action against the unjustly enriched employee and/or the breaching fiduciary, or against any party with respect to which the breaching fiduciary had a right of indemnification or contribution as a legal matter, on a subrogation theory. As a practical matter, $10,000 is too small an amount money to make litigation an economically rational approach. However, as a simple matter of equity, since it was most likely the employer, not the plan, that hired the miscaluculating TPA firm, the employer should act as financial backstop to prevent any loss to the participants and offset this loss against the savings it obtained by not doing a better job interviewing the TPA firm and having legal counsel review the standard form TPA agreement. Even though the employer may not have been directly responsible for the benefit overpayment, it may be exposed to fiduciary liability for any failure to monitor the TPA's computational methods and practices to ensure their accuracy and reliability, which is analogous to the employer's responsiblity to monitor the investment management practices of the investment fund managers, even though, in the context of an ERISA 404© Plan, it is sheltered from liability for losses that result from participant-directed investment decisions.

[This message has been edited by PJK (edited 06-22-2000).]