Curing excess 402(g) deferral after separation of service?

Does anyone have some insight on how we could remedy excess 402(g) deferral after the employee has separated service and transferred their account to an IRA?  I'm wondering if the IRA can be used to return the assets or if it would have to come from the original 401(k)?

Issue two (2) Form 1099-R. One for the for the excess deferral, and one for the rollover.  For example if total Rollover was $100,000 and Excess was $5,000 issue a 1099-R for $95,000 as rollover and another 1099-R as $5,000 excess deferral.

Notify the participant that $X.xx ($5,000 in my example) was not eligible for rollover due to excess deferral over 402(g) limit and that he must remove the excess plus any earning from his IRA or it will be subject to penalties each year it remains in the IRA. 6% excess tax IIRC but you can double check that. I believe he must remove it by the due date of his tax return with extensions to avoid the penalty, again you can double check on that.

Alternatively you can try to recover the excess from the IRA and then process as excess deferral from the Plan. I think this is the method the IRS would prefer as it's cleaner but is often much harder to accomplish with the participant and IRA custodian.

So who issues the 1099-R for the earnings? 

If that $5,000 is now worth $5,250, the former participant is getting cash totaling $5,250, but is only getting a 1099-R for $5,000.

What if the account lost value?  Say it's worth $4,750 now.  Do you issue an amended 1099-R for $4,750?

Ha, I'm going to naively say just write to the IRA custodian mentioning the fact pattern and see if they'll do what you tell them!  (I suppose in this case, issue the 1099-R only for the taxable gain/loss, since the plan would be issuing the form relating to the 5,000.)

Yeah, it's pretty messy, thanks for the input on it!

Side question, which I know I should know:

When there are excess contributions (either in this unusual case or just in a regular example) do we have to also remove employer matching contributions? I'm trying to figure out if that is the case how we'd even go about returning them to the prior employer.

RTD - your documents should address what happens to related matching funds on refunds.

On 12/15/2021 at 11:55 AM, Lou S. said:

RTD - your documents should address what happens to related matching funds on refunds.

Sorry wasn't being clear, I'm not administering the plan here, I'm working with the former employee and coming at it from their perspective. I understand that when there is an excess contribution we would remove the contribution and earnings associated with it, but once it hits the IRA that gets messy (per the original question) thereafter, I was wondering if they should should also withdraw the employer contributions, but if so that would also be challenging since it would seem that they would have to mail a check back to the employer and they'd also get a 1099-R from the IRA for that.

2 hours ago, matthny said:

they would have to mail a check back to the employer and they'd also get a 1099-R from the IRA for that.

The IRA shouldn't issue a 1099-R for that as it is a return of an ineligible contribution.  The Plan will issue 2 1099's--one for the rollover and one for the excess.  The IRA shouldn't be involved in the 1099s at all.

However, everyone must pay attention in this.  The plan will just be issuing the refund 1099-R for the excess and earnings gained (or lost) whilst in the plan.  (Maybe) the IRA custodian issues a 1099-R for the gains on the refund?  Or do the tell the plan and the plan will issue the refund 1099-R including plan and IRA earnings?  I do not like the latter, becasue then 1099-R's don't match up to distributions from the account.

And if there is a loss at the IRA, they need to tell the plan so it can issue the correct 1099-R?  Again, you have a problem with the 1099's not matching distributions.

Can you even do a negative 1099?