Employer returned 401k forfeiture. Can I put it back into an IRA?

My old employer's payroll department gave me an incorrect vesting date prior to my departure.  The company had a 3 year vesting schedule for 401k match.  They told me I was fully vested as of June 2021.  I left the company on 8/11/2021,  7 days short from my 3rd year anniversary date based on this communication with the payroll department.  Fidelity forfeited almost $7000 when I rolled over my 401k to a roll-over IRA account.  It was really surprising to me.  After discussions, the employer acknowledged their mistake and decided to just give me a check for the amount + extra amount to pay the tax.  The confusion was that ADP had a rule saying only 1000 hrs had to be worked in a year.  When the plan was moved to Fidelity, it was strictly about the anniversary date.  Now, I don't want to pay any penalty on this amount.  I would like to deposit back into an IRA account.  Is this even possible?  Wouldn't IRA consider this as a "withdrawl" from a retirement account and the amount would be subject to a penalty?  I am 50 years old.  I would like to know what my options are in this weird situation.  The employer said it's best to do it this way because their plan can be considered non-compliant and cause a lot of headaches.  I would appreciate what you professionals think about this situation.

What your former employer should do, is restore your forfeiture and pay you from the plan. That $7,000 that was forfeited went into a "forfeiture account" in the plan, and since this was all pretty recent, chances are it's still there. If it's no longer in the forfeiture account for whatever reason, then the employer would have to write a check to Fidelity - not to you personally - for the amount that needs to be restored to your account. Either way, once the money is back with Fidelity, the employer should instruct Fidelity to restore it to your account, then they should initiate a new distribution from the plan to the same IRA custodian.

This is, technically, a case of non-compliance. The good news is that the IRS provides easy-to-follow rules to fix plans when they have compliance issues, and as long as your employer does things the right way, they will not have any problems. If they try to pay you back outside of the plan it will cause bigger problems for both of you later on.

Thank you for your reply, C.B. Zeller.  What you described should be the right way.  Supposedly, Fidelity has an issue returning the money from the forfeiture account without changing my departure date to my 3rd year anniversary date.  So, that's not going to happen.

I probably should get what I can get before my old employer changes its mind.  For some time, they (Payroll & HR departments) weren't even responding to my e-mail/phone calls until I contacted the CFO since I knew him pretty well.  He told the Controller to take care of this and it's gotten this far.  I am happy at least they're going to pay me.  They said they are going to send me a letter to sign a release and they will issue me a check.  Even if I pay the 10% withdrawal penalty, it's better than losing the entire $7K.  They could easily tell me they're not going to pay me a penny although I have everything in writing.  Then, I have to go to a court and it gets messier.  Who has time for that and paying the lawyer is going to cost even more?  I guess paying the 10% early withdrawal penalty would be the worst case for me unless I am missing something.

I just wanted to know if I could deposit this back into an IRA to avoid the penalty.  I don't know why I have to go through this, but it just happened unfortunately.  The Controller told me to consult with a tax accountant or financial advisor what to do with the money.

The other key factor here is what type of tax form they are going to give to you at the end of the year.  For a retirement plan a 1099R tax form is issued.  If the company wrote you a check, they may be planning to issue a W2 or a 1099-Misc/NEC.  The correct way is a 1099R.  If they give you a W2 or 1099misc, the amount is not eligible to rollover to an IRA and you would not be subject to 10% tax. 

I've worked with Fidelity, they absolutely can do this. They might not make it easy, but it's possible. Your employer (or their third party administrator) might have to open a service request with Fidelity.

If they won't do it, look at your SPD for claim procedures. You have a right to bring a claim for benefits under sec. 502 of ERISA. Hopefully just asking for this info will get your employer in line, as you mentioned no one wants to have to bring it to the courts.

If they just cut you a check for $7,000, here are some of the consequences of that:

• It is not a plan distribution, so it can not be rolled over. If you are eligible, you could use it to make an IRA contribution (not a rollover), up to the annual limit ($6,000 plus $1,000 catch-up if you are over 50 for 2021).
• It is not a plan distribution, so there is no 10% early withdrawal penalty.
• If it is treated as wages (reported on W-2), it will be included in your income for federal and state income tax, FICA tax, etc.
• If it is treated as non-employee or independent contractor compensation, you could also owe self-employment taxes on it, plus you may have to file a schedule C to report the self-employment income on your 1040.

Even if your employer has you sign something that you agree not to come after them for the $7,000 from the plan later on, that would be unenforceable. Both ERISA and the Internal Revenue Code have anti-alienation and anti-assignment clauses, meaning that it is impossible for you to lose your rights to money that is owed to you under the plan, even voluntarily. So you could theoretically come back for it years from now, and they could still be liable.

Thank you all.  I think I understand my options.  So glad I posted my question here.

Or did the plan rules change to anniversary year at some point and Fidelity was correct, she was not fully vested. Just poor communication? In which case I can see why they want to pay her outside the plan since it may not be a plan error.

It sounds to me like the plan originally determined vesting based on the counting hours method, and then the plan transitioned to Fidelity with its prototype plan document that uses elapsed time for vesting.   Same result as what 30Rock stated.

I have had several plans recently switch went to Fidelity for record keeping.  In every case Fidelity insisted on changing to elapsed time method for vesting from hours of service.

A plan can switch from using the counting-hours method to the elapsed time method for vesting service. However it cannot reduce any participant's vested percentage. If the OP had already worked enough hours to earn a year of vesting service under the old schedule, the change could not then make him wait until his anniversary date to keep that vesting. We don't know exactly when the switch happened, or how many hours were required under the old schedule, so this may or may not be a concern.

However, the company's HR department represented to the OP that he was 100% vested, and he relied upon that representation. If the plan was properly amended and OP was not actually 100% vested, then that representation would not create an obligation for the plan to make him vested, however it could create a liability for the company who gave him incorrect information. That could explain why they are trying to settle with him outside the plan.