Non Qualified Distribution - Not able to repay

I'm looking for the rule that states what happens to the plan if a participant is allowed to take a non qualified distribution and is unable to repay the money back into the plan. IRS corrective actions state the money needs to be restored but doesn't state the ramification if it is not able to be restored.

The IRS has deemed a failure to follow the terms of the plan to be a disqualifying failure. Because this failure is a result, not of the document, but of the practices followed by the plan, it is an operational failure.
It is not important that the plan operations did not violate the technical provisions of the IRC. The fact that the operations did not comply with the plan document is the basis of the disqualification.

Not sure what exactly you mean by non qualified distribution, however, doesn't IRS Rev Proc 2016-51 §6.06(4)(f) allow a retroactive amendment to correct the error (assuming that the participant had a distributable event, but the Plan didn't allow for distribution on that event)? Of course the IRS only allows for retroactive amendment to correct an operational error for threespecific reasons under Self-correction, so you would have to do a VCP filing.

13 hours ago, tylerb172 said:

I'm looking for the rule that states what happens to the plan if a participant is allowed to take a non qualified distribution and is unable to repay the money back into the plan. IRS corrective actions state the money needs to be restored but doesn't state the ramification if it is not able to be restored.

 

If the participant can't or won't restore it, the plan sponsor must restore it. Typically, I believe, it would be returned to an unallocated account rather than becoming a windfall for the participant.

11 hours ago, K2retire said:

If the participant can't or won't restore it, the plan sponsor must restore it. Typically, I believe, it would be returned to an unallocated account rather than becoming a windfall for the participant.

That was modified by Rev. Proc. 2015-27.  The version in 2016-51 says:

Quote

6.06 (4)(b) Make-whole contribution. To the extent the amount of an Overpayment adjusted for Earnings at the plan's earnings rate is not repaid to the plan, the employer or another person must contribute the difference to the plan. The preceding sentence does not apply when the failure arose solely because a payment was made from the plan to a participant or beneficiary in the absence of a distributable event (but was otherwise determined in accordance with the terms of the plan (for example, an impermissible in-service distribution)).

I haven't looked at the new EPCRS Rev. Proc, to see if the wording is any different.

Here is the text from the new EPCRS Rev. Proc. https://www.irs.gov/pub/irs-drop/rp-16-51.pdf (page 37 & 38)

It looks to me like the ER still has to fund it to an unallocated account in 6.06(4)(c).

(4) Correction of Overpayment (defined contribution plans and 403(b) Plans). (a) In general. An Overpayment from a defined contribution plan or 403(b) Plan is corrected in accordance with the Return of Overpayment method set forth in this section 6.06(4). Under this method, the employer takes reasonable steps to have the Overpayment, adjusted for Earnings at the plan’s earnings rate from the date of the distribution to the date of the correction of the Overpayment.

(b) Make-whole contribution. To the extent the amount of an Overpayment adjusted for Earnings at the plan’s earnings rate is not repaid to the plan, the employer or another person must contribute the difference to the plan. The preceding sentence does not apply when the failure arose solely because a payment was made from the plan to a participant or beneficiary in the absence of a distributable event (but was otherwise determined in accordance with the terms of the plan (for example, an impermissible in-service distribution)).

(c) Unallocated account. Except as provided in section 6.06(4)(d), a corrected Overpayment, adjusted for Earnings at the plan's earnings rate to the date of the repayment, is to be placed in an unallocated account, as described in section 6.06(2), to be used to reduce employer contributions (other than elective deferrals) in the current year and succeeding year(s) (or, if the amount would have been allocated to other eligible employees who were in the plan for the year of the failure if the failure had not occurred, then that amount is reallocated to the other eligible employees in accordance with the plan's allocation formula).

(d) Repayment by the participant or beneficiary. To the extent an Overpayment was solely considered a distribution in the absence of a distributable event but was otherwise determined in accordance with the terms of the plan, any amount returned to the plan by the participant or beneficiary is to be allocated to his or her account.

(e) Notification of employee. Except as provided in section 6.02(5)(c) with respect to the recovery of small overpayments, the employer must notify the employee that the Overpayment was not eligible for favorable tax treatment accorded to distributions from an eligible retirement plan under § 402(c)(8)(B) (and, specifically, was not eligible for tax-free rollover).

(f) Other correction methods. Other appropriate correction methods may be used to correct Overpayment failures from a defined contribution plan. Depending on the nature of the Overpayment, an appropriate correction method may include using rules similar to the correction method in section 6.06(4)(a) but having the employer or another person contribute the amount of the Overpayment (with appropriate interest) to the plan instead of seeking recoupment from a plan participant or beneficiary. Another example of an appropriate correction method includes a Plan Sponsor adopting a retroactive amendment to conform the plan document to the plan’s operations (subject to the requirements of section 4.05). Any other correction method used must satisfy the correction principles of section 6.02 and any other applicable rules of this revenue procedure.

(c) applies if a deposit is made to correct the overpayment.  The last sentence of (b) that I put in bold says the employer is not required to deposit if the amount incorrectly distributed was part of the participant's vested balance.  If the distributed amount exceeds the participant's vested balance, the employer or someone else would be required to make a deposit. 

1 hour ago, Kevin C said:

(c) applies if a deposit is made to correct the overpayment.  The last sentence of (b) that I put in bold says the employer is not required to deposit if the amount incorrectly distributed was part of the participant's vested balance.  If the distributed amount exceeds the participant's vested balance, the employer or someone else would be required to make a deposit. 

Well, now that you put it like that it makes sense. 

In this instance the company setup a successor plan and notified their prior provided they would be transferring their assets. The prior TPA marked the employee as "terminated" and processed the distribution request. The employee received their pretax deferrals and vested employer balance.

Would this still apply? How can the employer replace pretax dollars?

On 10/5/2018 at 4:26 PM, 401_noob said:

Well, now that you put it like that it makes sense. 

In this instance the company setup a successor plan and notified their prior provided they would be transferring their assets. The prior TPA marked the employee as "terminated" and processed the distribution request. The employee received their pretax deferrals and vested employer balance.

Would this still apply? How can the employer replace pretax dollars?

On 10/5/2018 at 3:23 PM, Kevin C said:

(c) applies if a deposit is made to correct the overpayment.  The last sentence of (b) that I put in bold says the employer is not required to deposit if the amount incorrectly distributed was part of the participant's vested balance.  If the distributed amount exceeds the participant's vested balance, the employer or someone else would be required to make a deposit. 

in this instance the company setup a successor plan and notified their prior provided they would be transferring their assets. The prior TPA marked the employee as "terminated" and processed the distribution request. The employee received their pretax deferrals and vested employer balance.

Would this still apply? How can the employer replace pretax dollars?

tyler172, you are describing an impermissible in-service distribution, which is the case given as an example in the sentence I put in bold in the quoted 6.06(4)(b) in my first post above. So, yes, what I posted applies. 

You also asked about the consequences to the employee if he/she doesn't repay the impermissible distribution.  6.06(4)(e) says the employer must notify the participant that the distribution was not eligible for rollover treatment.  Looking at 6.09 (6) and 11.03(8), it appears the 10% early withdrawal penalty would apply even though it becomes ineligible for rollover, unless relief from 72(t) is requested as part of a VCP filing.  If you open the pdf for Rev. Proc. 2016-51 and search for "overpayment" and search for "72(t)", it will make it easier to find the applicable sections.

https://www.irs.gov/pub/irs-drop/rp-16-51.pdf