Excess (over plan limit) deferrals

[Guest A. Rostosky]

When an employee in a 401(k) plan exceeds the plan percentage limit for contributions, how is that excess deferral to be treated? Is a refund required? (Nothing is specified in the plan document).

[R. Butler]

We treat it the same as a 402(g) excess, but we have never been able to find specific guidance on this issue.

[Guest]

see also Q & A 107 under Correcting Plan Defects

[Guest Una M]

Must be returned and is taxable in year of distribution. Company match that exceeds plan limit should be forfeited, not returned.

[Erik Read]

I disagree with UNA M. I think you need to look to the document, sometimes they are silent, but once in a while someone has a draft with a line item discussing excess deferral's.

Aside from that I have always questioned if there isn't a distributable event, how you can justify the return to the participant? I've seen it done with a "negative" election on the following payroll - depends again on if the document is silent or not.

Good Luck.

[R. Butler]

In response to whether or not there is distributable event; we have always reasoned that the operational failure that creates a distributable event. One problem with the "negative payroll" method described is that gains/losses attributable to the deferrals are not properly handled.

Another concern with the "negative payroll" method described is that it isn't consistent with the correction methods for similar type violations. Violations such as 415 excess, ADP/ACP failures, 402(g)failures, etc. generally require refunds, forfeitures, and/or recharacterization.

[Erik Read]

Good points. Again - not suggesting that's the best way or only way, but that some documents I've seen have stated that as the correction.

I agree that it does not address gain/loss and that is a concern. I haven't heard the arguement that the ops failure creates the Distributable Event - haven't thought of it that way, do any other firms out there share in that thought? Are there any PLR's that have addressed that?

Thanks R. Butler - this is turning out to be a good topic!

[Guest Mr. X]

We handle it the same as R. Butler, similar to a 402(g) violation.

[Guest PC]

ASPA IRS Q&A 1998 Question #36

Q: Assume that an eligible NHCE in a 401(k) Plan defers in excess of the plan limits. The employee doesn't exceed 415 limitations. The employee defers 18% and the plan limit is 15%. Is there any justification to refund these funds? We believe that there is no legal basis for jettisoning the money and that this is a procedural problem, probably something that fits under APRSC. Do you agree?

A: This could be a potential disqualification since 3% too much went in. It should fit under APRSC, which would provide for taking the money out with interest. It would probably require correcting (increasing) the employee's W-2 statement to reflect the incorrect amount withheld for the plan.

ASPA IRS Q&A 1999 Question 42:

Q: A 401k Plan allows participants to defer between 1% and 15% of their compensation. An employee elects 15%, but, due to a payroll processing error, 17% of his compensation is deferred. The actual deferral is less than $10,000 and the error is not found until the subsequent plan year. There is no 415 violation. What, if anything, should the plan administrator due?

A: Refunding from the plan is NOT an acceptable APRSC solution, although it might work under VCR. The money should probably be forfeited an used in whatever way other forfeitures are used, with the employee being made whole outside the plan. However, we strongly argue that the "mistake of fact" argument does not apply to these contributions!

[R. Butler]

The reference that PC uses says the exact opposite of the Q&A reference Tom Poje provides. Interesting.

[Guest]

one year they say you should be able to correct under APRSC, the next year they say no.

The ERISA Outline Book gives an example (15.532)

..'this is an operational failure because the terms of the plan were not followed. The NORMAL CORRECTIVE action is to distribute the deferrals that exceeded the cap.' (emphasis mine)

it then goes on to say you could use Walk in Cap and put in a retroactive amendment to eliminate the cap instead.

so somewhere out there is a guideline that says, ok distribute the $. so the question is whether APRSC is ok.

the comment from the 1999 Q & A makes no sense since it talks about forfeitures, and that would not apply to deferrals - or at least, I never heard of it applying to deferrals. see also 2000-16 rev proc

section 6 Correction principles...

.02 Correction

2 Reasonable and appropriate correction

© ...keep plan assets in the plan...for example, if an excess allocation...(OTHER THAN A CASH OR DEFERRED ARRANGEMENT), excess should be reallocated to other participantso or reduce...

[John A]

Does the 1999 IRS response contradict the 1998 IRS response?

Also, this brings up the general question: when can and when can't "improper" deferrals be distributed to a participant. If there is any situation in which "improper" deferrals cannot be distributed, what is the appropriate correction?

Clearly, deferrals can be distributed to a participant due to ADP test failures (excess contributions), 402(g) limit failures (excess deferrals), and 415 limit failures (excess annual additions), including failures under EPCRS because the original possible corrective distribution was not made on a timely basis.

However, can deferrals be distributed for:

1) deferrals in excess of plan limit (the ASPA questions),

2) deferrals by employees who are not yet eligible for the plan

3) deferrals that should not have been allowed due to a hardship withdrawal restriction (the 12-month wait)

4) deferrals that were accepted by the trust even though the money came from a company that had been spun off and did not continue maintaining the plan,

5) deferrals by an employee who had changed employment status to a status not eligible for the plan

6) deferrals from severance pay that was received long after termination of employment,

7) deferrals from an independent contractor,

8) deferrals that resulted from a coding error (21% was withheld rather than the correct 12% deferral)

9) etc., etc., etc.

[Guest SeanT]

My experience is similar to the explanation PC described. If the document is silent on the matter (most seem to be), we have taken the approach that the "over contribution" may NOT be removed as an excess deferral due to the fact that it's not a 402(g) violation. Nor can it be removed as an excess contribution because it's NOT an ADP excess. This violation does not appear to constitute a "distributable occurrence." Our approach has been to keep this money as a asset of the trust and move the "over contribution" (and any attributable earnings) to the plan's forfeiture a/c and have the employer make the participant whole outside of the plan.

[R. Butler]

My main concern with forfeiting a deferral is that it is entirely inconsistent with any other correction method for similar type violations. Also, part of that remedy involves an action entirely apart from the plan, making the person whole. I am not at all convinced that the part of the remedy can be enforced. It don't see how it is covered by laws governing qualified plans.

[John A]

R. Butler,

I think part of the problem with deciding on the proper correction is whether or not you view the improper "deferrals" as deferrals. If the employer contribution to the plan that equals the amount withheld from the employee is considered a deferral, then there are grounds for distributing the deferral. However, if the employer's deposit to the plan trust is considered an employer contribution that has been improperly allocated to a participant (or to a non-participant), then you either have to go the forfeiture route, or explore the plan's provisions for returning an improper employer contribution due to mistake of fact.

Also, if you do distribute the "deferrals" and the IRS decides that no distributable event had occurred that would allow assets to leave the plan, then the correction used has caused another plan qualification issue (which is in conflict with another general correction principle in 2000-16).

The Code seems to be intentionally very narrow about when corrective distributions will be allowed. Distributions are only allowed for deferrals that were proper under the terms of the plan but that caused failures under 415, ADP, or 402(g). Nothing in Rev. Proc. 2000-16 broadens this scope to allow distribution of amounts that would not be allowable deferrals under the plan's terms.

If the improper "deferral" is viewed as an improper employer deposit, then forfeiture does resemble corrections provided for in other cases of improper allocation of a contribution.

Making the employee whole outside the plan is probably not covered by qualified plan rules, but not making the employee whole would be a pretty bad decision for most employers.

I do find it interesting that this is the one "common" operational plan defect that the IRS decided not to cover in Rev. Proc. 2000-16. Unfortunately it leaves a split in decisions of how to deal with the problem: some will opt to follow the 1998 ASPA IRS answer and distribute the money, others will follow the 1999 ASPA IRS answer and conclude that distributing the money is NOT an option. Other practitioners I've talked to seem to be firmly on one side of the fence or the other and there is no consensus.

Perhaps the only safe way to handle this situation is to use VCR (rather than APRSC) and make the IRS decide (and from the 1999 ASPA IRS answer, you still could not apply the VCR conclusion to the same issue that came up again and do APRSC next time - you'd still need to go VCR).

Until the IRS issues written guidance, I don't think there will be agreement on handling the issue of improper "deferrals".

[R. Butler]

John A.

Thank you for your response. I never really considered that it may not actually be considered a deferral. It doesn't change my opinion, but at least I understand the logic behind the other view.

I also agree that the best way to get definitive answer is someone to go through VCR and make the IRS decide, but that may not be likely. Most administrator's will use APCRS.

[Guest smithee]

Where can I find online or how can I get copies of the referenced ASPA Q&A's?

[Guest RJM]

1. Aren't Employee Deferrals 100% nonforfeitable at all times?

2. Is the excess considered in the individual's 415 test?

3. His 402(g)limitation? Before or after correction?

4. Does the excess affect the ADP Test?

5. Is it in the Top Heavy Test as a balance or distribution?

6. If distributed, is the excess taxable in the year deferred or the year distributed? What's the IRS Distribution Code (1099R box 7)?

[Guest]

for the aspa information you might try

http://www.aspa.org

the Q and A people cite are from the ASPA conferences. I don't know if they have them in a particular folder. however, you might be able to order the conference materials(all the talks for 2000 are on a CD ROM)