Returning 2014 deferrals to correct 2013 ADP failure

[fiona1]

A HCE took a full distribution from the 401(k) plan on 11/20/2013 and continued to work. He rolled all of these funds to an IRA> He resumed making deferrals to the 401(k) in January of 2014.

He is due a ADP refund from the failed 2013 test. Would it be okay to refund his 2014 deferrals to correct the failure? Or will the IRS deem a portion of his rollover ineligible, meaning that the refund amount should come from the IRA?

[Lou S.]

If there is money in the plan I see no reason not to make the refund from money in the plan. Of course you may have a problem in 2015 if the plan fails the test again and he doesn't have enough in his account to cover the refund but I say burn that bridge if you come to it.

[fiona1]

I tend to agree. I just wonder if there is an IRS agent would would be techincal about it and claim that the 2014 deferrals are not excess contribuitons for the 2013 plan year and were improperly refunded.

[Belgarath]

Unless I'm missing something here, the excess amount wasn't an "eligible rollover distribution" under 1.402©-2, - see Q&A-4. It seems to me that it already was distributed from the plan in 2013 (so no further amount is due from the plan for the ADP failure) but the IRA has an ineligible amount in it, and it must be distributed from the IRA.

Then again, maybe I'm looking at it backwards...

[MWeddell]

I agree with Belgarath. The better approach is to follow the letter of the law -- notify the employee that part of the 2013 distribution was not an eligible rollover distribuiton -- then to do what is more convenient.

[masteff]

It is only under the final sentence of Reg 1.401(k)-2(b)(2)(v) that if the participant's account has been fully distributed that the correction is retroactively applied to said distribution. I could easily argue under (b)(2)(v) that since the participant has an available balance now (at the time of corrective distribution) then those funds should be used to make the correction. The Nov distribution was not designated as a corrective distribution at the time it was made.

"(v) Distribution. Within 12 months after the close of the plan year in which the excess contribution arose, the plan must distribute to each HCE the excess contributions apportioned to such HCE under paragraph (b)(2)(iii) of this section and the allocable income. Except as otherwise provided in this paragraph (b)(2)(v) and paragraph (b)(4)(i) of this section, a distribution of excess contributions must be in addition to any other distributions made during the year and must be designated as a corrective distribution by the employer. In the event of a complete termination of the plan during the plan year in which an excess contribution arose, the corrective distribution must be made as soon as administratively feasible after the date of termination of the plan, but in no event later than 12 months after the date of termination. If the entire account balance of an HCE is distributed prior to when the plan makes a distribution of excess contributions in accordance with this paragraph (b)(2), the distribution is deemed to have been a corrective distribution of excess contributions (and income) to the extent that a corrective distribution would otherwise have been required." (emphasis added)

Personally, I would print that reg out, highlight the "Except as otherwise..." sentence and put it in the participant's file as documentation for why you made the correction from current funds. I don't see an auditor fighting it.

[MWeddell]

To my brain, the last sentence means that a portion of the 11/20/2013 distribution is now deemed to have been a corrective distribution. The introductory clause to the second sentence of that paragraph that masteff quoted means that the last sentence is indeed applicable.

In other words, I'm not persuaded by masteff's argument (but perhaps the original poster is).