401K Employer Over Contribution Dilemma

[Ready]

I received a call from an attorney out of the blue this week. They represent a company which I worked for up until 2017. When I left the company, they contributed a $20K bonus into my 401K as part of my severance package. During a recent audit they determined that the plan does not allow them to provide a bonus into the 401K unless I'm employed there on the final calendar day of the year (which I was not).

My own contributions to the 401K were under the $18K limit, and the total contributions including employer match and bonus were under the $54K limit that was in place in 2017. So as far as I can tell I did not violate any IRS regulation regarding contributions.

Their issue is that they violated their own plan rules. They requested to claw the money back from my 401K account and reissue it to me as payroll. However, I recently rolled over the money to a personal IRA, so the money is no longer accessible to them.

I've tried researching this issue on the internet and can not find any similar situation that I can learn from. It appears that while my employer violated their own plan rules, they did not violate any IRS regulations.

So I'm trying to determine if I have any exposure with the IRS for an illegal contribution, and if I have any liability to my former employer to return the money and allow them to reissue it as a payroll check.

I've been retired since I left the company and have no earned income. If I allow them to issue me a check as payroll it will push me over the limits to where my capital gains will go from the zero percent tax bracket to fifteen percent. So this could be a very costly issue for me.

Can anyone suggest where I might be able to go to further research this? I tried calling Fidelity and speaking to three different people there and none of them had any idea how to handle the situation. The 401K and my Rollover IRA are both with Fidelity.

 

[njhowie]

Tell them very politely that you're very sorry that they are in this situation, but it was not your doing, and you have absolutely no responsibility to them. You acted in good faith, let the company make the necessary accounting adjustments on their side. If their rules were violated, let the accounting person who messed up take the fall. Again, not your problem.

Simply do not cooperate with them and the next time they call, tell them to please not call you again and any correspondence must be in writing..."So I can give it to my attorney". If they violated their own rules and messed up in your favor, that is their problem. Coming back two or three years later, after you no longer work for them is not acceptable!

Seriously, what are they going to do? They can't go and take the money from the account at Fidelity. Are they going to take you to court and sue you? Very doubtful. They'll be laughed out of the court room.

Tell them if they wish to pursue the matter, going forward they are going to have to handle it through your attorney.

You owe them nothing - it's your money.

 

[Ready]

Tell them very politely that you're very sorry that they are in this situation, but it was not your doing, and you have absolutely no responsibility to them. You acted in good faith, let the company make the necessary accounting adjustments on their side. If their rules were violated, let the accounting person who messed up take the fall. Again, not your problem.

Simply do not cooperate with them and the next time they call, tell them to please not call you again and any correspondence must be in writing..."So I can give it to my attorney". If they violated their own rules and messed up in your favor, that is their problem. Coming back two years later, after you no longer work for them is not acceptable!

Seriously, what are they going to do? They can't go and take the money from the account at Fidelity. Are they going to take you to court and sue you? Very doubtful. They'll be laughed out of the court room.

Tell them if they wish to pursue the matter, going forward they are going to have to handle the matter through your attorney.

You owe them nothing - it's your money.

Thanks for the quick reply!

Your thinking is right along with how I was looking at it. I'm just trying to confirm that I don't have any exposure to the IRS if I leave the contribution in my IRA. It appears that no general IRS rule regarding 401K contributions was violated here, but if a plan prohibits certain types of contributions, could the IRS say those are not legal contributions?

 

[Just_Steve]

Tell them very politely that you're very sorry that they are in this situation, but it was not your doing, and you have absolutely no responsibility to them. You acted in good faith, let the company make the necessary accounting adjustments on their side. If their rules were violated, let the accounting person who messed up take the fall. Again, not your problem.

Simply do not cooperate with them and the next time they call, tell them to please not call you again and any correspondence must be in writing..."So I can give it to my attorney". If they violated their own rules and messed up in your favor, that is their problem. Coming back two or three years later, after you no longer work for them is not acceptable!

Seriously, what are they going to do? They can't go and take the money from the account at Fidelity. Are they going to take you to court and sue you? Very doubtful. They'll be laughed out of the court room.

Tell them if they wish to pursue the matter, going forward they are going to have to handle it through your attorney.

You owe them nothing - it's your money.

^^TLDR^^
Tell them to pound sand.

 

[iloveyoga]

If they could find out where the rollover was made, they could tell that company that the funds were not qualified and not eligible for rollover, and the rollover company would then have to take action.

 

[njhowie]

Thanks for the quick reply!

Your thinking is right along with how I was looking at it. I'm just trying to confirm that I don't have any exposure to the IRS if I leave the contribution in my IRA. It appears that no general IRS rule regarding 401K contributions was violated here, but if a plan prohibits certain types of contributions, could the IRS say those are not legal contributions?

I am certainly not a professional in this area, but I don't really see how. I remember when I worked for megacorp, we were allowed to contribute any amount of our bonus in to the 401K. So long as the annual contributions were below the cap, it was perfectly fine.

The sticking point about being able to have the bonus fully go to the 401K requiring being employed there on the last day of the year does not have anything to do with the amounts, but rather the criteria. I really do not see how the IRS would have any concern or interest about that.

I might tell the attorney that you are amenable to their solution, but if they want to reissue as payroll, they will have to pay for a number of items to have your cooperation:

1. give you the gross-up to cover the taxes on the $20K
2. fees for you to hire an accountant to modify/correct/refile your 2017 taxes
3. any penalties and interest the IRS may assess for going back, filing the modified 2017 return, and potentially being audited as a result
4. any taxes and penalties which may be due for withdrawing the money from the 401K now

Essentially, you require that you have the full $20K in your hand at the end and be made whole. If they say that you would have had to pay the taxes on the $20K if it showed up as payroll in 2017, my response would be "Well, it is now 2020".

 

[njhowie]

If they could find out where the rollover was made, they could tell that company that the funds were not qualified and not eligible for rollover, and the rollover company would then have to take action.

How could the funds not be eligible for rollover if their plan administrator did the rollover to Fidelity?

 

[iloveyoga]

The contribution should not have been made in the first place, per OP. So that part of the rollover really should not have occurred.

They may not ask about it again, but these funds were not qualified to roll over. You could certainly ask to be made whole for taxes, etc as it was clearly their error.

 

[Ready]

I might tell the attorney that you are amenable to their solution, but if they want to reissue as payroll, they will have to pay for a number of items to have your cooperation:

1. give you the gross-up to cover the taxes on the $20K
2. fees for you to hire an accountant to modify/correct/refile your 2017 taxes
3. any penalties and interest the IRS may assess for going back, filing the modified 2017 return, and potentially being audited as a result
4. any taxes and penalties which may be due for withdrawing the money from the 401K now

Wow, that could get really expensive. I was planning to ask for the gross up but I hadn’t thought through the accounting fees to modify tax returns. Yikes, this could get very messy for them.

 

[Ready]

If they could find out where the rollover was made, they could tell that company that the funds were not qualified and not eligible for rollover, and the rollover company would then have to take action.

I would think there is an electronic record showing the institution the funds were transferred to so I’m guessing they already know I moved it from the Fidelity company 401K to a personal Fidelity Rollover IRA. I don’t think there is any way to hide that from them.

 

[MRG]

I would think there is an electronic record showing the institution the funds were transferred to so I’m guessing they already know I moved it from the Fidelity company 401K to a personal Fidelity Rollover IRA. I don’t think there is any way to hide that from them.

Doesn't matter. Fidelity is not going to get involved. Fido will tell them nothing except hire an attorney to go after you.

 

[Jerry1]

Just keep telling them that you’ll do whatever they need you to do as long as it’s financially neutral to you. Put everything you can think of in the bucket of neutrality. Don’t be dishonest but be as complete and creative as possible. Taxes, tax filing fees, any administrative cost from Fidelity, your time on the phone, gas for driving around thinking about this . . .anything that makes any sense. And last but certainly not least any attorney fees if things go beyond a couple of cooperative phone calls with them. Then see how they react.

 

[njhowie]

Another point to keep in mind, and possibly use in your approach - from what I found, laws regarding overpayment of payroll specify that if the employer overpays you, they have 8 weeks to notify you of the overpayment and then 6 years to claw back. However, they are required to notify you within 8 weeks that they made the overpayment mistake. If they do not notify you within the 8 week window that they overpaid you, then the money is yours and they cannot take it back. If by mistake they paid you an obvious ridiculous amount (let's say $10 million when your salary is $100k) in the first place, maybe they would sue to get it back. I would think that this is a similar situation. Two to three years is an extremely long time for notification. It would make sense that there must be some statute of limitations that would apply.

The amount we're talking about here is not in dispute. The correct amount of money was paid, simply an issue of where that money was put. Where the money was put was not illegal and did not violate any laws. So, the question becomes "Is there any benefit for the company in taking legal action against you or putting additional (significant) time, effort, and expense in to this in pursuing"? I really do not see how.

I might just skip all the foreplay ask the obvious question of their attorney - "What will you do if I do not agree"? Then regardless of the answer, say "Thank you, I need to think about it a little first".

 

[EastWest Gal]

To me it doesn’t seem they have a legal leg to stand on. The policy that you have to be employed by the company on the last day of the year in order to be eligible for the bonus money to go into your 401K, is just that, a company policy. It’s not an IRS rule. Am I missing something here?

 

[Bamaman]

When they say they violated the terms of their plan, it was probably the terms of their agreement with Fidelity.

That's their issue, not yours.

Backing off on the transaction would open too many cans of worms. I think your thinking correct about no IRS regulations being violated.

Tell'em to take a hike, and don't contact you again. Don't furnish them anything in writing either.

 

[Ready]

What I can’t figure out is what is in it for them to fix this mistake by clawing back the money and reissuing the same amount as a payroll check. Is it possible that there is a fine associated with this transaction that could be mitigated by reversing the transaction?

 

[iloveyoga]

The employer has a duty (IRS DOL?) to be sure that only "qualified" funds are in the qualified tax advantaged plan. The issue with Fidelity would not really be their concern, but Fidelity only wants qualified money in tax advantage rollover accounts.

 

[Ready]

The employer has a duty (IRS DOL?) to be sure that only "qualified" funds are in the qualified tax advantaged plan. The issue with Fidelity would not really be their concern, but Fidelity only wants qualified money in tax advantage rollover accounts.

I understand that, but given that the money is no longer in their 401K plan what difference does it make to them?

 

[Jerry1]

The employer has a duty (IRS DOL?) to be sure that only "qualified" funds are in the qualified tax advantaged plan. The issue with Fidelity would not really be their concern, but Fidelity only wants qualified money in tax advantage rollover accounts.

Okay, then does OP have a problem if unqualified money is in the account? Does it become taxable or even worse, taint the entire account?

 

[mrfeh]

Tell them very politely that you're very sorry that they are in this situation, but it was not your doing, and you have absolutely no responsibility to them.

+1

 

[pb4uski]

Well, the first thing that I would ask them to do is to put it in writing. The second thing I would do is to tell them that my research indicates that no IRS rules were violated since my contributions were under the $18k limit and the total contributions were under the $54k limit and ask if they concur with that conclusion. Then I would say that they have created quite a problem for themselves and let them respond. I might also enquire what the penalty is for them violating their plan rules.

If I was in a good mood, I might offer an olive branch that I might be amenable to their proposal as long as they agreed, in writing, to make me whole for taxes, the cost of amending returns, any penalties and interest, loss of ACA subsidies as a result of the increased income and my and legal representation costs.... and if I didn't trust them to uphold their part of the deal I would want an amount sufficient to cover all those costs placed in escrow with my attorney.

If they did as they proposed, would the $20k bonus be income to you in 2017 or 2018 when the bonus was credited to your 401k or in 2020 when you receive it?

 

[iloveyoga]

Yes, the Fidelity issue would be that money that was not qualified went to a tax advantaged IRA rollover. They accepted it based on it coming from a qualified plan. Not fun for the employer to sort out or for the individual involved. Nobody will be happy with the outcome. It is possible they will drop it, but usually not once an attorney is involved, in my long ago experiences.

 

[Ready]

Yes, the Fidelity issue would be that money that was not qualified went to a tax advantaged IRA rollover. They accepted it based on it coming from a qualified plan. Not fun for the employer to sort out or for the individual involved. Nobody will be happy with the outcome. It is possible they will drop it, but usually not once an attorney is involved, in my long ago experiences.

When I spoke to Fidelity about this they told me that they were not the plan advisor on the account. They said if they were the plan advisor they would have to get involved but since they were only hired to do the record keeping they did not want to get involved.

I think the plan advisor is a very small company that just gets paid an annual fee to answer questions about investing from employees. I can't even find their contact information so I'm not sure if they have been involved in this.

 

[Ready]

If they did as they proposed, would the $20k bonus be income to you in 2017 or 2018 when the bonus was credited to your 401k or in 2020 when you receive it?

That's a good question. I'm not sure yet.

About three weeks ago I received a surprise check for around $5K in the mail from them. It was dated December 28th but I did not receive it until January 2. I then received an email a couple of days later letting me know that due to a recent audit I was going to be receiving a disbursement from the 401K because I was deemed a highly compensated executive and there was not enough participation from the lower income employees to allow me to make the full contribution.

What really irritated me is that they knew the check was coming in 2019 but did not mail the check nor notify me of the issue until 2020. So I did not pay the anticipated taxes on the money and now I'm going to be hit with a penalty for underpayment on my California tax returns for 2019.

They did inform me the money would be counted as 2019 income. So I'm guessing that the $20K, if reissued, would likely be 2020 income. But so far they have not said anything.

This was the catalyst for me doing the rollover. I didn't want to have to worry about them doing an audit for the next year and issuing me another last minute surprise check.

 

[pb4uski]

You might also ask if the auditor recommended any remedial actions and if so, what they were. Often the audit report will just flag the issue and be silent on remedial action but sometimes it will flag the issue and recommend one or more remedial actions... if could be that there are other remedies that they are not pursuing because they are more onerous than getting you to agree to a reversal.