Distribution paid too early to a terminated participant

A client called because they were pressured by their platform to approve a distribution and agreed to it.  Unfortunately, their document is written so that there is a one-year wait on distributions (because there are usually errors in deposits that we have to reconcile after the end of the plan year).  But let's say that we are confident that this particular person has no deposit errors, so the distribution was 'correct' in the amount (vested amount, deposits, etc.), just about ten months too early.

I know that they have violated the terms of their document.  But what is the downside/correction?  It's not really an "overpayment", is it?  I'm not seeing anything remotely applicable in EPCRS 2018-52.  Thanks.

Has the plan asked the distributee to pay back the plan's money?

The current EPCRS Rev. Proc. is 2019-19, not 2018-52.

This is an operational error, i.e., failure to follow your plan document, as you note. Prior to Rev. Proc. 2019-19, the only way to self-correct this error would be to seek repayment. Under VCP, which required a submission to IRS, you could probably get the IRS to agree to just let it go this one time, subject to a requirement that you sharpen your administrative procedures so that it would not happen again. In VCP the IRS would probably also let you amend the plan retroactively to remove the 1-year wait for distributions, which is an unusual requirement, and one that would appear prone to error. These VCP options are still open to you.

But new Rev. Proc. 2019-19, the new EPCRS guidance, now lets plan sponsors amend plans retroactively to true up the plan document to actual operations, as long as the change is what I will refer to, for lack of a better term, positive for participants in all ways. Such a retroactive amendment qualifies as self-correction (I.e., no VCP submission to IRS required) as long as it is corrected within the standard 2 plan year correction window for "significant" errors under longstanding EPCRS rules governing SCP. So you generally can self-correct the failure to follow your plan document by amending it to conform to your actions, if your actions were uniformly better for participants (larger benefits, more rights or features) than what you had in your plan document.

If the change is permanent and covers all participants from and after the date of the change, you should be well within the new rule for retroactive "positive" amendments. But if you want to narrow the amendment, e.g. just have it apply for last year, you might not fit within the parameters of VCP. If you want to self-correct by plan amendment, you need to carefully review the rules with the assistance of counsel and determine whether they apply to your facts. Worst case, you make a VCP application. Or, as stated at the outset, you try to get the distribution back from the participant.

Let's thank Luke Bailey for an interesting idea.

Would a plan amendment of the kind described be a satisfactory correction if the plan's administrator had applied the wait to other participants who, but for the wait, were entitled to a distribution?

Peter, this is a new feature of EPCRS under Rev. Proc. 2019-19 and the IRS has not provided a lot of detail, other than to say that the amendment cannot reduce any benefit, right or feature (which the one in your hypothetical would not), and must satisfy the requirements of 410(b), 401(a)(4), 411(d)(6), etc. Addressing your hypothetical, of course, if they did a one-off amendment for one individual and he/she was an HCE, it would violate 401(a)(4). In theory if the participant in question is non-highly compensated, it seems to me that you might be able to do just a one-off for the one individual, but I'd really have to give that more thought before pulling the trigger on it for a client. If they just permanently removed it for everyone, it would seem more clearly to fit the guidelines in 2019-19.

Why not just self-correct under Rev Proc 2019-19, Section 6.06(4)?

Under 6.06(4), unlikely, generally, that the participant would be willing to return the "overpayment" - so then the employer or "another person" would need to contribute a "make whole" contribution. I doubt the employer would be too thrilled with this solution unless it was a VERY small distribution. Otherwise, it requires a corrective amendment under 4.04(5) such as discussed above.

So while it is a viable solution, I'm dubious that it will generally be the solution of choice.

When the overpayment actually belonged to the participant who received it, the requirement for a repayment by the employer or other person was removed from the correction method a couple of EPCRS revisions ago.

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)).

The OP assumption is that the correct amount was paid, but it was paid 10 months early, so the sentence I've highlighted applies.  I agree with Lando, why not self correct?

Kevin C, I agree with your point, but under 6.06(4)(b) you still have to make a good faith attempt to get the participant to repay. But it's definitely an option.

Kevin, good point. I forgot about that.

I have a question about these "make-whole" contributions.

What happens when the participant takes their entire account, say $10,000 early and in service, and doesn't pay it back.  The ER is supposed to put $10,000 back into her account? 

What happens when she leaves?  Does she get another 10 grand?

What about distribution fees?  Those ,too?

1 hour ago, BG5150 said:

I have a question about these "make-whole" contributions.

What happens when the participant takes their entire account, say $10,000 early and in service, and doesn't pay it back.  The ER is supposed to put $10,000 back into her account? 

What happens when she leaves?  Does she get another 10 grand?

What about distribution fees?  Those ,too?

 

If the participant doesn't repay an improper distribution of his/her entire vested benefit, the participant's vested balance is now zero.  The employer has to make a reasonable effort to get the employee to repay the distribution. If the participant does repay it, it goes back into his/her vested balance.  If not, treat it as a distribution, revise procedures, document the self correction and move on.

If the overpayment exceeds the participant's vested balance, then the employer would be on the hook to make a deposit if the participant doesn't repay the overpayment.  What happens to the employer's payment depends on the situation.  The easiest example is a terminated participant with a $10,000 balance with $8,000 vested, but receives a distribution of $10,000 and refuses to repay the overpayment.  The employer (or someone else) would need to deposit $2,000 plus lost earnings, which would be used to replace the forfeitures that were supposed to result from the distribution. One of the goals of EPCRS is to put the plan back in the position it would have been in if the failure had not occurred.