401(k) Payout to Participant Not Terminated

[lkpittman]

Employer changed an employee from salaried to "per diem" and somehow admin/payroll or someone accidentally "coded" this person as terminated for the plan purposes. This participant was provided the opportunity to receive a distribution from the 401(k) plan, and, of course, took the money (only about $1,000 or so). There is no specific correction for this qualification failure in Rev Proc 2000-16 (EPCRS), but we have advised the client to seek repayment from the participant in the manner described for overpayment due to vesting error or 415 overpayment. The employer will probably have to put the $$ back (plus interest)--they already know that the participant won't do it. We have also advised them that they can reduce future payments to this participant to recoup the amount (as allowed for 415 corrections). Does anyone see a problem with this for a 401(k) plan self-correction? Any input would be appreciated.

[QDROphile]

Recouping the correction amount from participant pay sounds aggressive. APRSC corrections shouldn't be aggressive. Attribute the $1000 employer loss to education in the school of hard knocks.

[lkpittman]

Thanks for the feedback, QDROphile, but we won't be reducing her "pay" to recoup the amount; we plan on reducing any future benefit payable to her by the plan by the amount repaid by the employer, so that she does not, in effect, receive a double benefit. This method (reducing future benefit payments to recoup the overpayment) is okay under Rev Proc 2000-16 for failures relating to a 415 excess. Why do you think it is too aggressive in this scenario? Thanks.

[QDROphile]

Still aggressive. There is no indication in the guidance on corrections that you may reduce a benefit to which a participant is entititled by the terms of the plan as a method of correction of an operational error. Section 415 is not a good analogy. It seems harsh that the employer would pay in a situation that provides a participant with a double beneift. But the employer usually pays because of the error. And participants don't forgo future accruals undar a plan to correct an error. A better analogy is the correction procedure when elective deferrals are missed. The employer pays and the participant gets a windfall -- a plan contribution and no reduction in pay. Tough luck for the employer, but that is what the IRS says. Be mindful of it whether or not you think you have the moral high ground. You can reduce a perticipant's account to adjust for mistaken accruals to the account. That can happen in many situations. But this is not a reduction of an incorrect accrual. This is a restoration of an improper reduction (by distribution), which is not a basis for adjustment by reduction of a future correct accrual.

[lkpittman]

Since there is nothing "on point" in the guidance--our attorney is going the aggressive route (don't they always?). I think we'll actually be okay--we're not actually reducing her benefit--it will be accounted for in the plan; she simply already received part of her accrued benefit and any additional payouts to her of her benefit will reflect the amount she has already received. Thanks for your input.