401K Employer Over Contribution Dilemma

[Ready]

Of course, if OP officially put in notice and retired, then there would be no severance. As far as the company is concerned, OP was terminated. Whether OP decided to look for work, or just call it a career, is none of their concern.

Then again, if reclassification gets everyone off the hook, it could be the way to go.

OP, were there any retiree benefits that you claimed upon leaving? Retiree medical, for instance. If so, it might make it easier to make the case.

No, it was a termination. The position was eliminated. There were no retirement benefits.

But if I simply take the last sentence and interpret it literally as it was written without getting into what my or my employer’s intent was, I did retire. So I think a good argument could be made that I’m not required to meet the end of year employment condition.

 

[Big_Hitter]

what is the definition of "retirement" in the plan document?

typically this is an age and/or service condition

you can't just argue "peace out, hey I retired" it has to satisfy the definition in the plan document

 

[Ready]

what is the definition of "retirement" in the plan document?

typically this is an age and/or service condition

you can't just argue "peace out, hey I retired" it has to satisfy the definition in the plan document

I do not see a definition of the term retirement in the plan. This is the closest paragraph:

3. Retirement
If you are an Employee of your Employer or a Related Employer at the time you attain your normal retirement age of 65.00, your Account balance will automatically become 100% vested.

So it does establish a “normal retirement age” of 65. I’m still in my 50’s so I did not achieve their definition of normal retirement age. But I don’t see anything in the document preventing someone from retiring early and receiving any lesser benefits.

But I get the fact that it’s a little bit of a stretch to say I retired, given that my separation was their decision.

 

[Big_Hitter]

yes but if you terminated after satisfying the age and service conditions for retirement you are deemed to have "retired" under the plan - this may not be in the SPD; you may have to request a copy of the actual plan document.

 

[Ready]

One thought that has crossed my mind about all of this is that while a bonus is eligible to be deposited into a 401K, a severance payment is not. And so while they paid me the $20K as a bonus, there is a separation agreement offering me severance in return for a release of liability.

If the auditors were able to review that letter they would see that the $20K payment was clearly not a bonus and may make the argument that calling it a bonus for the purpose of directing it into the 401K was done fraudulently.

If that is the case, the issue could be more serious for the company. It wasn’t my request to do this so I don’t think I have any liability here, but it could taint my ability to keep the money in the IRA.

 

[Ready]

yes but if you terminated after satisfying the age and service conditions for retirement you are deemed to have "retired" under the plan - this may not be in the SPD; you may have to request a copy of the actual plan document.

I’m reviewing a 20 page agreement titled “Summary Plan Description”. Do you think there is a longer document with more detail?

 

[Big_Hitter]

I’m reviewing a 20 page agreement titled “Summary Plan Description”. Do you think there is a longer document with more detail?

yes, there has to be and the plan administrator has to give you a copy of it if you ask for it

plan documents are legal documents are are much longer than 20 pages

 

[pb4uski]

Yeah, the retirement definition might be a glitch... even though I left employ to retire (no longer work), technically I just quit since I didn't have the combination of age and service sufficient to retire.

 

[cathy63]

what is the definition of "retirement" in the plan document?

typically this is an age and/or service condition

you can't just argue "peace out, hey I retired" it has to satisfy the definition in the plan document

Yes, this is exactly what I was going to say. I have money in two plans that I can't collect yet because I don't meet their definitions of "retired" even though I'm never planning to work for money again.

I also don't think they're going to be able to say this was a "qualified non-elective contribution". You said earlier that you were an HCE and they sent you back part of a prior year's contribution. According to the language you posted, qualified non-elective contributions are limited to non-HCEs and they're only for the purpose of allowing the plan to pass the non-discrimination testing. A severance payment to an HCE who elected to have it paid into the plan doesn't meet those criteria.

 

[Ready]

I will ask for a full copy of the plan next time I hear from the attorney.

This is a very small company (200 employees). There are no retirement benefits being offered to retirees. There is nothing in the document entitling someone to any benefits based on number of years of service or age. There is a one year vesting period for the match, but that’s about it.

 

[Ready]

I also don't think they're going to be able to say this was a "qualified non-elective contribution". You said earlier that you were an HCE and they sent you back part of a prior year's contribution. According to the language you posted, qualified non-elective contributions are limited to non-HCEs and they're only for the purpose of allowing the plan to pass the non-discrimination testing. A severance payment to an HCE who elected to have it paid into the plan doesn't meet those criteria.

Looking back at that section, I believe it’s the Qualified Matching Contributions that are limited to non-HCE’s, not the Discretionary Non-Elective Contributions.

 

[pb4uski]

It was classified as a bonus. However, in reality it was severance. I had not previously received a bonus from this company. This was the first time.

When I was separating from the company I was offered the $20K in return for signing a mutual release of liability. So I would say it was clearly intended to be a severance payment.

When the company was getting ready to issue the payment, the HR director called me up and asked me if I would like to have the $20K deposited in to my 401K as a bonus. It was not something I requested nor gave any thought to, but since they offered to do it, I said “sure, that sounds great”. I just assumed they knew what they were doing since they were the ones that offered it to me. I never personally requested it.

It sounds like it was comp because you could have taken it in cash and the HR guy's action caused you to make an overcontribution.

 

[CardsFan]

It sounds like it was comp because you could have taken it in cash and the HR guy's action caused you to make an overcontribution.

I think this is correct. Technically, OP made the over contribution by directing the money to the 401k, and this could cause problems down the road.

I think I would work with the company to determine the amount (including gains), return that amount to the 401k, if possible, then let them take it back and send you a check.

But before doing anything, I would get the opinion of a tax expert.

 

[Ready]

I’ve been curious as to what would have happened had I rolled over the money into an IRA immediately after leaving the company. When they did their first audit and determined that I was an HCE would they have had any ability to demand I send back $5K from my rollover and have them reissue it as a paycheck?

 

[cathy63]

I’ve been curious as to what would have happened had I rolled over the money into an IRA immediately after leaving the company. When they did their first audit and determined that I was an HCE would they have had any ability to demand I send back $5K from my rollover and have them reissue it as a paycheck?

They probably only did one audit and found multiple issues, which they're remediating one-by-one. The return of $5K excess contributions was one issue, and I'm guessing they got that one taken care of before you did the rollover? (Because if you had already rolled the money over, then sending that refund check was another big mistake on their part.) The $20K severance payment is a second issue.

What should have happened if you'd rolled the account over in 2017 and they later found that they failed a non-discrimination test is that they'd issue a corrected 1099-R showing the amount that was supposed to be in the account prior to the rollover and a second 1099-R showing that the $5K was a taxable excess contribution. 1099s also go to the IRS of course, but they may or may not connect the dots and look for an amended return if there's a significant delay between the original and corrected 1099s.

This is basically the same thing they're going to do if they deem the $20K to be wages instead of employer contribution, except there won't be a correction since they've discovered the problem before issuing the first 1099s.

 

[Big_Hitter]

^ you (are/were) in the benefits business?

 

[Ready]

They probably only did one audit and found multiple issues, which they're remediating one-by-one. The return of $5K excess contributions was one issue, and I'm guessing they got that one taken care of before you did the rollover? (Because if you had already rolled the money over, then sending that refund check was another big mistake on their part.) The $20K severance payment is a second issue.

What should have happened if you'd rolled the account over in 2017 and they later found that they failed a non-discrimination test is that they'd issue a corrected 1099-R showing the amount that was supposed to be in the account prior to the rollover and a second 1099-R showing that the $5K was a taxable excess contribution. 1099s also go to the IRS of course, but they may or may not connect the dots and look for an amended return if there's a significant delay between the original and corrected 1099s.

This is basically the same thing they're going to do if they deem the $20K to be wages instead of employer contribution, except there won't be a correction since they've discovered the problem before issuing the first 1099s.

From a practical standpoint, is it common for companies to issue a 1099 to a former employee who has long left the 401K plan if they deem them to be an HCE years after the contribution was made?

 

[cathy63]

^ you (are/were) in the benefits business?

Only out of self defense and to protect the people who reported to me. I worked for several small companies with untrained office admins who were just assigned to "do HR stuff too" and they frequently needed to be straightened out about various labor laws and regulated benefits. I've also helped several people understand some screwed up tax situations that were related to 401K rollovers either being done incorrectly or being documented incorrectly on 1099-Rs.

 

[cathy63]

From a practical standpoint, is it common for companies to issue a 1099 to a former employee who has long left the 401K plan if they deem them to be an HCE years after the contribution was made?

I've definitely seen it but it was a much shorter timeframe. The employee left the company in I think 2015 and rolled over his 401K around June of that year, and he got the original 1099 in January 2016, followed by the corrected ones a few weeks later.

And actually, now that I've Googled it, the IRS' "401(k) Plan Fix-It Guide" makes it seem like it should be impossible for them to recharacterize the money more than 2.5 months after the end of their plan year, though it looks like they could take longer to actually distribute it. If you haven't made any contributions since 2017 and I'm reading this IRS info right, then assuming their plan year is the calendar year they shouldn't have returned any of your contributions after the end of 2018. You might ask the lawyer about this when you next talk to him. edit: never mind, reading further down the page they do have the option to return the contribution for 2 years, but they'll pay a penalty.

This plan is thoroughly screwed up!

If your plan fails the ADP or ACP test, you must take the corrective action described in your plan document during the statutory correction period to cause the tests to pass.

The plan has 2 ½ months after the end of the plan year being tested to correct excess contributions. The plan can distribute excess contributions any time during the 12-month period. If correction is not made before the end of the 12-month correction period, the plan’s cash or deferred arrangement (CODA) is no longer qualified and the entire plan may lose its tax-qualified status. You may correct this mistake through EPCRS. If the employer doesn't distribute/recharacterize excess contributions by 2 ½ months (six months for certain EACAs) after the plan year of excess, the employer is liable for a 10 percent excise tax on excess contributions.

The tax doesn't apply if the plan sponsor makes corrective qualified nonelective contributions within 12 months after the end of the plan year if the plan uses current year testing. However, if the corrective contributions are insufficient for the CODA to pass the ADP test, the tax applies to the remaining excess contributions.

There are two different methods to correct ADP and ACP mistakes beyond the 12-month period. Both require the employer to make a qualified nonelective contribution to the plan for NHCEs. A qualified nonelective employer contribution (QNEC) is an employer contribution that is always 100% vested and subject to the same distribution restrictions as elective deferrals. Forfeitures can’t be used to pay for QNECs.

https://www.irs.gov/retirement-plan...-the-401k-adp-and-acp-nondiscrimination-tests

 

[Ready]

I’m lost. Where does this leave me? Can the employer pay a 10% penalty to make this go away or do I still need to remove the $20K plus interest from my IRA?

 

[cathy63]

I’m lost. Where does this leave me? Can the employer pay a 10% penalty to make this go away or do I still need to remove the $20K plus interest from my IRA?

I think you'll have to wait and see what the attorney proposes as a solution. The IRS page I linked above doesn't address the issue with your $20K, it only answers whether they could have made the $5K taxable if you had rolled over the money back in 2017. The answer to that is yes, as long as they did it by the end of 2019.

Here are a couple of other IRS pages about what the employer should do if they used the wrong definition of compensation and what they should do if they allowed you to exceed the deferral limits, but without knowing which one they claim they did, it's hard to say what should happen next.

https://www.irs.gov/retirement-plan...n-correctly-for-all-deferrals-and-allocations

https://www.irs.gov/retirement-plan...lendar-year-and-excesses-were-not-distributed

 

[Ready]

I think you'll have to wait and see what the attorney proposes as a solution. The IRS page I linked above doesn't address the issue with your $20K, it only answers whether they could have made the $5K taxable if you had rolled over the money back in 2017. The answer to that is yes, as long as they did it by the end of 2019.

Here are a couple of other IRS pages about what the employer should do if they used the wrong definition of compensation and what they should do if they allowed you to exceed the deferral limits, but without knowing which one they claim they did, it's hard to say what should happen next.

https://www.irs.gov/retirement-plan...n-correctly-for-all-deferrals-and-allocations

https://www.irs.gov/retirement-plan...lendar-year-and-excesses-were-not-distributed

OK, got it. Thank you very much for all of your help with this. I’m a bit overwhelmed at how complex it has become.

 

[Brat]

It might be possible for the former employer to take the position that this was forced, if premature, retirement because of corporate restructuring. The fact that a release of liability was executed was because of his age and that the money was paid as a part of a retirement agreement. The OP in fact retired.

The question in my mind is who is going to go after the employer for this error?

 

[Texas Proud]

This was many many years ago so the rules might have changed...


There was also a limit to the % of salary you could contribute besides a hard $ limit...


Company did an audit and determined I was over the limit... they took the money out and issued me a check at 1.25% of what was removed as a gross up (mentioned earlier)... now, my taxes were not 25% so I made out on this mistake...

 

[Ready]

This was many many years ago so the rules might have changed...


There was also a limit to the % of salary you could contribute besides a hard $ limit...


Company did an audit and determined I was over the limit... they took the money out and issued me a check at 1.25% of what was removed as a gross up (mentioned earlier)... now, my taxes were not 25% so I made out on this mistake...

25% gross up seems like a reasonable offer to compensate for the employer’s mistake. Unfortunately for me the $20K payment this year would push me from the 0% tax bracket for capital gains to the 15% bracket, so I would have to pay capital gains tax on all of my gains as a result of the income. So it’s likely to cost me around $10K in extra taxes. But I’m not expecting them to make me whole on that. I’m just hoping they will call me a retiree and forget the whole thing.