Another Ineligible 401(k) Contribution Question

[401kAllTheWay]

I am sure this has been asked many times but I do not see anything similar to my challenge. 
Unfortunately, terminated employee was paid and had 401k withheld. Employee is returning the entire paycheck but due to system processes, our team was advised that we cannot choose which deductions to return - the whole check will be voided to look like it didn’t happen. 
Enter having to correct with our record keeper - we have advised the compliance way to correct - send over to record keeper for self correction, they will calculate the earrings, and issue 1099-R to offset W-2. If we do not have our record keeper complete there could be an employee loss to make whole or if there are gains, we still have ineligible funds in the Plan. 
I was basically told to just figure it out make it work. My make itwork way would be to follow our record keepers advice but getting pushback on the business because of their system limitations.

how would you go about correcting? How would we be able to calculate earnings or losses on a contribution that has been in the Plan for months?

thank you. 

[Paul I]

It would help if you could be more explicit about the circumstances.  Was the employee:

• terminated from employment,
• paid in full any and all compensation due to that employee, and
• then another paycheck was given to the now terminated employee even though the terminated employee was no longer entitled to any further compensation?

If this is the case, then the situation is totally a payroll screw up and none of the money in the plan belongs to the participant.  You could work with the recordkeeper to have the amounts removed from the employee's account, and possibly made available to pay a plan expense.

If the circumstances are that any part of the paycheck represents compensation due to the participant, then payroll should void the paycheck and reissue a paycheck to the now terminated employee for the correct amounts.  Any amounts that are in the plan that do not belong to the employee may be treated as above, and any amounts that to belong to the employee can be paid or forfeited under the terms of the plan.

Keep in mind that this approach hinges on whether any part the paycheck was actual compensation due to the employee.  If the answer is yes, then the plan received in part or whole some amount of a legitimate contribution that must be dealt with based on plan rules. 

[401kAllTheWay]

Thank you for your reply. 
The employee is terminated and had been terminated for quite some time.  The employee was not entitled to the compensation given to them. The company is requesting the erroneous paycheck back and the terminated employee is sending back to the company. 
My understanding from the mishap is since this is in the Plan now, we must remove any of the funds associated to the contribution which includes gains. Our record keeper would calculate and send a 1099-R to offset the W-2 issued.

I was told a check would be issued but now thinking about this, none of the funds should go to the participant since this was an incorrect payment. Feel like I am causing wheels to spin on a complicated mishap. 
 

Edited to Add - I am thinking a check would only be issued if there are earnings on the contribution. 
 

[Paul I]

I suggest providing these details to the recordkeeper.  They should be able to zero out the participant's account and move the money (including any earnings) to a company account or forfeiture account within the plan.  You can then deal with how best to apply the dollars in the plan that are due to the payroll error.  Any recordkeeper that has been in the business for even a short while has had to deal with payroll errors where too much money is in the plan that doesn't rightfully belong to any participant.

[Bill Presson]

Agree with Paul. Just move the dollars to a forfeiture/suspense account and have the company use it to offset a contribution. Don't overcomplicate it.

[pmacduff]

I "third" that motion...transfer to forfeiture account!

[Bri]

I'll agree too!  

(And add, this at least smells more like a reasonable claim for "mistake of fact" than most excuses folks try to throw out there.  But definitely just fix it the easy way as everyone above is suggesting.)

[msmith]

Payroll error seems more like an amended W-2 and not a 1099-R issue.

[401kAllTheWay]

Thank you all. We asked about mistake of fact but this was met with the record keepers process.  I appreciate all of your thoughts in a chaotic situation we were put into. Hoping things go more smoothly for the next one.