ADP Test failure was not as bad as thought=>overpmt to HCE

[TPApril]

Plan has one HCE who is not an owner. ADP test failed and HCE received $15,000 in excess contributions.

ADP test was rerun and determined that too much in excess contributions were distributed earlier this year (ie no 1099-R issued yet) and refund should have only been $10,000.

HCE is happy to return the $5,000 to the plan in order to reduce tax liability.  Earnings that were added on to the refund will be prorated and returned as well.

Ultimately the 1099-R will reflect the lower amount..

I believe this is an acceptable correction, but not sure if we need to calculate earnings on that amount since it was refunded to include with the repayment..

[Artie M]

I guess the new rules seem to say you don’t have to put in the additional earnings, though under the old rules you would

Here are my thoughts:  The erroneous portion of the distribution constitutes an inadvertent benefit overpayment within the meaning of 414(aa) and Notice 2024-77. 414(aa), added by SECURE 2.0(?), generally provides that a qualified plan will not fail to satisfy 401(a) merely because the Plan does not obtain repayment of an inadvertent benefit overpayment. 2024-77 provides that the corrective-payment requirements otherwise contained in Rev. Proc. 2021-30 §6.06 generally no longer apply to an inadvertent benefit overpayment.

Although recovery now is not required to preserve the Plan's qualified status, the HCE has voluntarily agreed to return the overpayment. So, under these rules it seems the HCE would return to the Plan the $5,000 overpayment and the earnings attributable to the $5,000.

2024-77 says that no additional payment by the employer is required solely because of the inadvertent benefit overpayment.  Note under the 2021-30 §6.06 the employer may have had to return the overpayment plus earnings.   I looked at 2024-77 again and Q&A-2 is unusually strong, providing that, subject to the specified exceptions, “any requirement described in section 6.06 of Rev. Proc. 2021-30 that a corrective payment be made to a plan … no longer applies.”  That means to me that post-distribution earnings are no longer mandatory, just like a potential employer-make-up.

One item… to not do earnings though, note that 2024-77's definition excludes an overpayment to a §4975 disqualified person or §401(c) owner-employee. You said this HCE is not an owner, so that exclusion does not appear to be a problem—but you should confirm they aren’t otherwise a §4975 disqualified person (officer, 10% shareholder, etc.).  I don’t think it’s a big deal because they’re returning the overpayment.  However, if they don’t meet this definition, then I think you go back to including earnings as you go back to 2021-30.

Some could say just include earnings to be sure, but note that if you aren’t required to provide earnings an argument could be made that you are favoring the HCE and permitting them additional deferrals… . haven't thought that through.