money purchase plan overdeposit

[AlbanyConsultant]

I've got a NFP MP plan with an hours requirement to get the allocation.  They make deposits during the year to estimate the annual contribution (it's a straight formula, so in theory this is easy to calculate each month).  This year, they put in too much because someone ended up not working the required hours.

So this is an excess contribution to the plan based on the formula, not the 415 limit for anyone (and not over 404, not that they have a deduction to worry about).  Does it have to be refunded?  Any penalty?  I know the plan sponsor is going to want to let it stay in the plan; is that subject to an excise tax then?

 

Thanks.

 

[Bird]

I get the idea these are self-directed accounts? If so, you have an overdeposit error to one person's account and we would typically "forfeit" it (using that term loosely) and apply it to the next contribution for someone else. If deposits are made after the end of each month it should not be an overage for the whole year although I guess it is possible.

One way or another, the money should stay in the plan and be used against a future contribution. 

I'm honestly not sure about excise taxes when having what essentially becomes a "pre-deposit" when there is no deduction problem. If you had too much money in the plan before the end of the year on a plan-wide basis, I think I'd be inclined to carry it as a liability, use it up the next year, and move on. 

[Lou S.]

Without thoroughly researching, my guess would be that the excess that is not allocated to participants would be a non-deductible contribution subject to the excise tax and that it would be deductible in the following year when allocated.

[Peter Gulia]

If an excise tax would apply and no other remedy or accounting fits, the employer, the plan’s administrator, and the plan’s trustee each might want advice to evaluate whether a contribution was made “by a mistake of fact” so that, if within one year after the payment of the mistaken contribution, the trustee might return the mistaken amount to the employer.

[Paul I]

The Senate Finance Committee - Secure 2.0_Section by Section Summary 12-19-22 FINAL describes Section 316:

Amendments to increase benefit accruals under plan for previous plan year allowed until employer tax return due date. The SECURE Act permits an employer to adopt a
new retirement plan by the due date of the employer’s tax return for the fiscal year in which the plan is effective. Current law, however, provides that plan amendments to an existing plan must generally be adopted by the last day of the plan year in which the amendment is effective. This precludes an employer from adding plan provisions that may be beneficial to participants. Section 316 amends these provisions to allow discretionary amendments that increase participants’ benefits to be adopted by the due date of the employer’s tax return. Section 316 is effective for plan years beginning after December 31, 2023.

Under this provision, the plan could amend the plan before the due date of the tax return to increase the contribution rate enough to absorb the excess contribution.

The description of the effective date in the summary arguably is unclear when can this provision could be used.  Is it available in 2024 to amend a 2023 plan? Or, does the amendment have to be applicable to a plan year beginning after December 31, 2023?

The language in the statute says "EFFECTIVE DATE.—The amendments made by this section shall apply to plan years beginning after December 31, 2023." This phrasing points to being able to first use this in a 2025 plan year to amend a 2024 plan year. 😢

[AlbanyConsultant]

To answer some of the questions...

On 1/22/2024 at 1:19 PM, Bird said:

I get the idea these are self-directed accounts? If so, you have an overdeposit error to one person's account and we would typically "forfeit" it (using that term loosely) and apply it to the next contribution for someone else. If deposits are made after the end of each month it should not be an overage for the whole year although I guess it is possible.

One way or another, the money should stay in the plan and be used against a future contribution. 

I'm honestly not sure about excise taxes when having what essentially becomes a "pre-deposit" when there is no deduction problem. If you had too much money in the plan before the end of the year on a plan-wide basis, I think I'd be inclined to carry it as a liability, use it up the next year, and move on. 

This is a pooled plan, so no single participant individually is overdeposited.  They look at their payroll for the month, multiply it by the percentage, and deposit that amount.  Which is fine unless someone doesn't meet the hours requirement (in this case, someone left and came back so I told them the person was still eligible... but they ended up only coming back part-time and didn't meet 1,000 hours).  "Forfeiting it" and holding it to credit the 2024 allocation is just a paper entry.
 

On 1/22/2024 at 1:39 PM, Lou S. said:

Without thoroughly researching, my guess would be that the excess that is not allocated to participants would be a non-deductible contribution subject to the excise tax and that it would be deductible in the following year when allocated.

I'm not sure there is an issue with non-deductible contributions because non-profits don't deduct.  While almost a quarter of a century old (!!), I did find this discussion on these boards:
https://benefitslink.com/boards/topic/4781-deduction-for-contributions-sec-404/

Kevin Donovan writes that it isn't applicable to an NFP, though there is a dissent where the Pension Answer Book is referenced (noted that the PAB has no citation)... and no further discussion.  But since the PAB was brought up, I found an old copy (like, 10+ years old), and Q12:13 "Does the excise tax imposed on nondeductible contributions apply to tax-exempt organizations?" says that there is no excise tax applies if the entity has always been tax-exempt (there are additional caveats and such), citing IRC 4972(d)(1)(B), 4980(c)(1)(A), and a PLR 200020009.
 

On 1/22/2024 at 2:04 PM, Peter Gulia said:

If an excise tax would apply and no other remedy or accounting fits, the employer, the plan’s administrator, and the plan’s trustee each might want advice to evaluate whether a contribution was made “by a mistake of fact” so that, if within one year after the payment of the mistaken contribution, the trustee might return the mistaken amount to the employer.

While I now believe that an excise tax doesn't apply, this is not a bad idea in general (if they were a for-profit) because the deposit was made due to a reasonable error in estimating compensation (well, eligible compensation).

Thanks for the great answers, everyone.  I think I'm going to suggest just leaving it in the plan as an excess deposit since there is no penalty to do so.  Hmmm, I wonder if that will come back to bite me later when the NFP decides to front-load a large amount 'to be used next year'... nah, that would never happen, right?

[Bird]

FWIW my recollection of the "mistake in fact" determination is that it is very narrow - the example given by the IRS was having a wrong DOB. I could be wrong but I thought they even said something like overestimating comp was not a mistake in fact. The narrow definition is a typographical or mathematical error. That is, if the comp was off by a decimal point, that is a mistake in fact, but putting money in for someone who is not eligible is "a screw up" to quote someone who posted on this in 2007.

[Peter Gulia]

If an employer requests a return of an amount the employer says it contributed by a mistake of fact, it is the plan’s trustee—or, if the trustee is directed, the plan’s administrator—that decides whether the contribution was made by a mistake of fact.

ERISA § 403(c)(2)(A)(i) [29 U.S.C. § 1103(c)] does not define what is or isn’t a mistake of fact.

No Labor department rule interprets this. No Treasury department rule interprets this.

Plans’ fiduciaries differ widely in their interpretations about what is or isn’t a mistake of fact.

[Paul I]

The EOB has a fair amount of discussion about a mistake of fact that includes some tenuous references to sources.  The discussion most on point with this thread says:

"1.b. Tentative contribution for employee who fails to accrue benefit for plan year is not subject to return under mistake of fact. The Joint Committee on Employee Benefits of the American Bar Association posed this question to the IRS in an informal technical session conducted in 2001. Suppose an employer, for budgetary reasons, deposits monthly to the accounts of participants in a 401(k) profit sharing plan. It is determined after the close of the plan year that some participants don’t qualify for the contribution because they fail to satisfy the plan’s last day employment requirement. May the funds revert to the employer? The IRS’s response was that the funds could not revert to the employer because the IRS doesn’t view estimates as a mistake of fact."

Looking collectively at the various sources that dealt with mistake of fact situations, it seems the IRS says "we will recognize it when we see it, and we will let you know if we see it."

[AlbanyConsultant]

Well, if I don't have to resort to this, then I won't!