Lawsuit settlement - contributions to 401(k)?

[Belgarath]

At this point, going on nearly NO details - just a quick second-hand question based on a phone call from a plaintiff's attorney. We will of course be telling the client to talk with his legal counsel. But as much as I understand the situation so far:

A participant terminated employment in 2023. He was an owner, and was bought out. Apparently, there is some sort of a lawsuit - the nature of which I have no idea, but the terminated participant is apparently getting some sort of settlement, and wants to know if he can contribute to the 401(k) for 2025 to save on taxes. The plaintiff's attorney wants to talk to us, apparently.

This is way above my pay grade/knowledge, but I'd like to have some idea for my own background. I "think" I generally have an idea that a "restorative payment" which is determined under the facts and circumstances (Revenue Ruling 20something-25 - can't remember specific number) is not considered a contribution subject to 404, 415, etc., etc.) But this dealt with fiduciary breach-type situations as I recall.

Assuming for the moment that this lawsuit is for other reasons, perhaps wage issues, unjust termination of employment, whatever, if the settlement is considered wages, then if he was still employed by the employer, he should be able to defer up to the normal limit. But, since he terminated in 2023 I don't believe he could defer into the plan. Could he?

Please don't waste a lot of time on this, because as I said, it'll be handled by the client's ERISA attorney, and/or the plaintiff's attorney and/or tax counsel. But for my own edification, if you might have any quick general info based on your experience, I'd be grateful for anything you might care to share. We've been fortunate to never have run into this situation.

Thanks!

P.S. - The Revenue Ruling I was thinking of is old - 2002-45. No wonder I couldn't remember...

[Peter Gulia]

If a portion of the settlement might be “back pay” for wages (or, arguably, self-employment income) that would have happened had the claims complained-of not happened, there might be some opportunities for applying a participant’s elective-deferral election, matching or nonelective contributions (to the extent the plan provided), and years of service (possibly for eligibility, benefit accrual, and vesting).

“Back pay.  Payments awarded by an administrative agency or court or pursuant to a bona fide agreement by an employer to compensate an employee for lost wages are compensation within the meaning of section 415(c)(3) for the limitation year to which the back pay relates, but only to the extent such payments represent wages and compensation that would otherwise be included in compensation under this section.” 26 C.F.R. § 1.415(c)-2(g)(8) https://www.ecfr.gov/current/title-26/part-1/section-1.415(c)-2#p-1.415(c)-2(g)(8).

But the details of how to write the settlement agreement; how to allocate amounts to particular plan, limitation, and tax years; and how to time and document elections are tricky.

And there are other employee-benefits issues.

If your client does not have a regularly engaged employee-benefits lawyer or that lawyer wants to add one who is specially knowledgeable for this situation, Bradley Horne (Super Lawyers Rising Stars: 2024, 2025, 2026) at Smith & Downey has a developed knowledge of how to handle the retirement, health, and other employee-benefit plans’ aspects regarding settlements of employment-related disputes.

https://www.smithdowney.com/professionals/bradley-j-horne/

[Belgarath]

THANKS PETER! This is very informative - I do appreciate it. I'm sometimes disgusted at how much I don't know after all these years in the business.