Participant's Account Balance Beneath Cash-out Threshold; Amount Distributed Exceeded Threshold

Company X sponsors a 401(k) plan. Participant A terminates employment in 2025 with an account balance of $6,985. X directs X's account balance to be cashed out. A couple months later, based on favorable investment performance,  a check is issued to A for $7,055. Has the 401(k) plan committed an operational failure by issuing a check to a former employee for more than the cashout threshold?

Was it a default RO check? Otherwise, it would have to had been elected by A (so no problem), and if a direct payment be net of 20% tax w/h (again, no problem if taxes w/h). 

CuseFan, assume for this purpose that it was not elected by the participant and also that the amount of the distribution was the gross amount before the 20% mandatory withholding.

This invites a question about why there was a long delay between the plan administrator’s instruction and the distribution.

If a distribution is processed promptly after the measure of whether an account balance is within or beyond the cashout threshold, there should not be a wide increase in the investment value.

Also, if the distribution was an involuntary distribution, did the distributee choose receiving it in money? Or, ought the distribution to have been a rollover contribution into an IRA?

BenefitsLink neighbors, what do you think about this potential correction: The plan’s administrator invites the distributee to restore $5,644 (or the net paid after tax withholdings)? The employer/administrator (or a breaching service provider) restores to the participant’s account the amounts withheld for taxes? If the distributee declines to restore the net amount, treat this as a ratification of what was done?

This is not advice to anyone.

I see two operational failures (at least as described in the original post):

1. The second sentence states that "company X" directs the "cashout".  I hope it is the Plan terms that do the directing.  (Possibly this is not a real problem, other than poor phrasing.  Just being cautious, maybe it's worthwhile to read the relevant plan provisions for verification.)
2. The distribution appears to be 100% of the account.  This implies the participant was never offered an opportunity to do a rollover. As @CuseFan states, this might be OK if the check was issued as a "rollover check".

17 hours ago, Peter Gulia said:

why there was a long delay between the plan administrator’s instruction and the distribution

Peter, w/o knowing the exact facts, I do not see the time lag as problematic. My thought being, if done properly, the Plan Administrator (also likely Company X) instructs RK or TPA to initiate the involuntary cash out process which entails providing a 402(f) notice and at least 30 days in the election period. Adding administrative time on the front end and back end, a couple of months from start to finish is not unreasonable (if this is indeed how the situation unfolded).

That begs the question and the initial ask from rocknroll2, if the cash out process begins when the account is under the threshold but exceeds such at the time of distribution, may it still be paid without consent?

I recognize the need for required and desired notices (and for some time before and after the notice period). But:

Can the plan administrator’s instruction to its service provider be “Process the involuntary distribution if, on the scheduled date, the participant’s account is no more than $7,000.”?

Likewise, can a notice to a participant say an involuntary distribution will be paid as a rollover to the default IRA if the account is no more than $7,000.”?

I can imagine "the worst part" being, you check the balance every day, but because it's in mutual funds or pooled separate accounts, the first day it shows as $6998 and the sponsor tries to force it out then they'll find at the close of business they're back to $7004.

But that's because I ascribe to the idea that the value when it actually occurs is the value that matters.

I remember when the 3,500 law used to say that once you crossed it, it is deemed to always be crossed regardless of market drops.  I wouldn't mind a ruling clarifying that if it were under the limit within the last 30 days or something.....

For BenefitsLink neighbors thinking about rocknrolls2’s question, here’s the statutes:

ERISA § 203(e)(1):  Consent for distribution; present value; covered distributions.—If the present value of any nonforfeitable benefit with respect to a participant in a plan exceeds $7,000, the plan shall provide that such benefit may not be immediately distributed without the consent of the participant.

Internal Revenue Code § 411(a)(11)(A):  If the present value of any nonforfeitable accrued benefit exceeds $7,000, a plan meets the requirements of this paragraph only if such plan provides that such benefit may not be immediately distributed without the consent of the participant.

I wanted to clarify a couple of things about my original question: (1) we are in the midst of delving into the facts surrounding the timing of when the distribution was directed by the plan sponsor and when the actual distribution was made. Therefore, it is likely that the interval between the date the distribution was directed and the date that the distribution was actually made could be much less than a few months.

I recall that earlier in 2025, there were some wide swings in the securities markets resulting from a great deal of uncertainty and complete confusion about the short-term and possibly long-term direction of the global economy which likely caused dramatic swings in value. Luckily, for those not taking distributions, history has shown that, over the long haul, investing in the equity markets not only evens out any short-term spikes in losses but far exceeds the rate of return over any other investment vehicle, notwithstanding the Great Depression. However, it is a frequent occurrence that the timing of a participant's decision to request a distributions when the market is at a high point and the time it takes to process the payment could include very sharp downward swings. It is hoped that if there are substantial upward swings during the period between the initiation of a distributions and the participant's receipt of the payment, in an involuntary cash-out scenario, that the fact that the value of the account balance upon receipt of the distribution being in excess of the involuntary cash-out threshold would not be considered an operational failure.

Regarding correction, Rev. Proc. 2021-30, Appendix A, .07 deals with situations in which the distribution is made without the participant's (and, where applicable, spouse's) consent. However, it is not helpful as applied to a 401(k) plan in which the only distribution option is a lump sum. The prescribed correction method is an after-the-fact consent, an election to receive distribution as a QJSA or the distribution of a single sum equal to the present value of the survivor annuity payable upon the participant's death. The problem is that annuities are not an allowable form of distribution under the plan and the participant has received his/her entire account balance. It would be hoped that when the IRS ever gets around to superseding the Rev. Proc. in light of SECURE 2.0 and other recent developments, it would allow the plan to merely seek an after-the-fact consent from the participant. The reason I said tender is that the participant may decide that since s/he got the money, it is a useless gesture to sign the consent form.

I apologize for being overly wordy here, but I felt that these points were important to add.

Consider also:

Internal Revenue Code § 411(a)(11)(A) states a condition for treating a plan as a tax-qualified plan.

Whatever relief one might obtain under tax law does not cure an ERISA title I failure to administer the plan according to its provisions.

ERISA § 203(e)(1) states a command: “the plan shall provide[.]” If a plan’s administrator violates that provision, the participant may pursue ERISA § 502 legal and equitable relief.

But if there was an unconsented-to distribution, might the plan simply let the distributee put the money back into the plan?

Or if the distributee wants to keep the money where it is, treat that communication as a ratification of, and consent to, the distribution that was paid?

This is not advice to anyone.