Return of Over Payment with Excess Contribution from IRA

[Below Ground]

Early in 2022 person requested in-service distribution.  Distribution was processed before we as TPA even received 2021 Compensation, and person's compensation for pre-2021 was not even close to HCE Threshhold Amount.  Data for 2021 was received shortly after processing distribution and turns out person's 2021 compensation is over the Threshhold, making this person HCE for 2022.  ADP Testing for 2022 results in the need to payout Excess Contribution.  Problem is that the in-service basically zeroed out the person's deferral account, so there is nothing left under the Plan to payout the Excess.  Monies for the in-service were rolled into an IRA.  We notified the IRA of the Excess in February 2023, but the IRA did not get back to us until now.  They gave us a form to pay out the Excess as an Excess Contribution, but now they say they can't do that for some undeclared reason.  The IRA wants to pay money back to the Plan which would then pay out the Excess now.  Of course, the IRA was subject a investment loss, so the amount won't even cover the Excess.  A bigger concern is that the Excess was around $5K, so if paid back to the trust and then paid out now, there will be an excise penalty tax of around $500.  The question is what is the best way to deal with this Excess Contribution?

[Lou S.]

I would treat it just like failed ADP test after total distribution. (See instruction to Form 1099-R the procedure is in there)

I believe the procedure is you amend the 2022 1099-R and issue 2 1099-Rs, one for the excess contribution and the other for the rollover.

The excess contribution is not eligible for rollover so the participant needs to be instructed to remove the excess contribution (along with earnings/loss). The IRA should have forms to remove the excess IRA contribution. It does not need to be returned to the Plan.

[Bri]

Right - do right by the plan first, since that's your client.  If the plan does what IT is supposed to, the rest is on the participant.

[Below Ground]

The problem is that the person rolled over the in-service distribution to John Hancock, which is where the plan is held.  You might expect this would make the issues easier, but they are saying the money must be returned to the plan, and it is they who issue the 1099 Forms.  Regardless, I will try to get them to issue the revised 1099 Forms.