Ineligible Participant Profit Sharing Distribution

Hi Folks,

I believe I have a fairly unique and messy situation that I’m hoping to get opinions on. An annual compliance review was completed by a TPA and they provided a profit sharing calculation for an ineligible participant (who was also terminated). The plan sponsor funded the contribution to said participant and triggered a residual distribution. The transaction was sent to the TPA for review and was approved, even though the participant should (1.) Not have been eligible to receive a contribution and (2.) Should not have been allowed to take a distribution of these funds.

The plan sponsor has decided that it’s going to be less of a hassle for them to allow this individual to keep the funds as a “bonus” (for a multitude of reasons that don’t need to be explained here). The individual is not an HCE but I still have concerns.

In my opinion, the plan would still need to be made whole because the assets that went into the plan never should have been segregated from the plan and now, the sponsor is looking at having to fund double the original amount to make the plan whole.

Here is my question: considering that the TPA provided an online approval of the distribution (to my knowledge, the sponsor was not prompted to provide an online approval), at which point could a TPA be held responsible for a loss like this?

Ultimately, I know that the sponsor of the plan is responsible for operating the plan but we are in this business because we are the subject expert matters and plan sponsors should be able to rely on their third party providers to help them avoid costly mistakes like this, especially when the third party overlooks important details such as participant eligibility when providing profit sharing calculations.

In the world of defined contribution plans, the aspirational standard is perfection.  In the real world, stuff happens and mistakes happens.  The abundance of rules dedicated to correcting mistakes is a testament to our imperfection.

The guiding principle behind the rules in general and EPCRS in particular is to do no harm.  The plan sponsor has the ultimate responsibility to choose the correction method that will keep whole all of the other participants.  If the plan sponsor is okay with the chosen correction mehtod, so be it. 

As a further testament to our imperfection, TPA's almost universally have errors and omissions insurance coverage.  The plan sponsor separately can decide if they wish to pursue reimbursement from the TPA. 

By noting that stuff does happen, I am not an apologist for less than perfect services.  What is important is how the TPA works in good faith with the plan sponsor to make the correction, and also what a TPA does to prevent the same stuff from happening again to any client.

Also, you don't fully describe the error, in particular the errant contribution. If the error was not made, would that have resulted in more of a contribution allocated to other participants (we contributed $X to be allocated to those eligible based on pay) or simply would that contribution amount not been made at all (we wanted to contribute X% of pay for those eligible)?

If the former, then the defect likely warrants correction where someone (employer, TPA, shared) makes the plan whole by funding, and then such is allocated. If the latter, participants have not been harmed, this is simply an inadvertent error the plan sponsor can choose not to recover.