401K Employer Over Contribution Dilemma

[iloveyoga]

This was a bad error on their part. If they don't forget about it, you could reasonably ask them to make you whole.

 

[HokieHi]

Not a dilemma for you

This is an accounting problem for your former employer. I suspect they can figure out how to re characterize the severance package without bothering you. I wouldn't fret over it.

 

[HokieHi]

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 don't see how you can assume these funds were not qualified. It sounds to me more likely that the funds were characterized as a Bonus. Most companies only pay bonuses to current employees. But this is strictly internal policy stuff. IRS and IRA's don't care whether the funds are bonuses or wages. It is all compensation. Each year when I was employed, I would receive performance and merit bonuses. 401 deductions were taken from those funds just like my regular salary.

 

[2cheap2eat]

Don’t forget you may have to refile your 2017 tax return as well. I’d politely say they messed up and you no longer have income/assets to “roll it back”

 

[mickeyd]

Seems like a minor ERISA violation. If they call back, tell them that they should hope that a future DOL inspection does not find it. DOL does very few inspections. It's the employer's problem, not yours.

 

[pb4uski]

.... It's the employer's problem, not yours.

Is it the employer's problem though? It sounds to me like the severance bonus/comp was taxable compensation to the OP that the employer erroneously allowed him to defer which when combined with the OP's other contributions resulted in the OP being overcontributed for the year. If the IRS interprets that way it could pursue the OP for an overcontribution, and in that case it is the OP's problem as well.

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.

 

[Ready]

I think it’s a shared problem. The employer is responsible for knowing the rules and ensuring that only qualified funds are allowed in the plan. But if they fail to follow the rules and allow an employee to over contribute it becomes a problem for the employee as well. I’m just not sure how it needs to be resolved.

I asked the attorney a week ago how he wants to proceed and he still has not responded back to me.

 

[pb4uski]

I think you got it right... it was their mistake and therefore their problem but it also creates problems for you. At the sime time, since the whole mess is a result of their mistake I hope that they make you whole for any damages.

 

[rick55]

Im tired of all the phone calls I get from people looking for bail money for my grandson (I dont have one), the IRS coming to arrest me, and all the other scams out there. It has made me so suspicious that I do not answer the phone unless I know the caller.

Scammers are so sophisticated now, and they could be ex co- workers who may have some inside knowledge. I would not entertain any phone call asking for money. And no court would blame me.

This seems to be one of those calls...

 

[pb4uski]

.... This seems to be one of those calls...

Huh? I think I'll have a few Bloody Mary's too.

 

[Ready]

I last posted in this thread a year ago when I thought the issue had been concluded but it came back to bite me this morning.

Quick recap: An audit from my former employer lead them to realize a final bonus they paid me as a 401K contribution was not allowed by their plan. They requested I return the money and have them reissue it as a payroll. This was income earned in 2017. I had already rolled over the money into an individual IRA. I asked their attorney how they wanted to handle it given that the funds had already been transferred out of the plan and never got a response.

Today I received a 1099-R from Fidelity for approximately $21K in taxable distributions from my 401K, so it appears I have to report this as taxable income and an early withdrawal from my 401K. It was labeled as Distribution Code E - Employee Plans Compliance Resolution System.

My understanding is that early withdrawals are subject to a 10% penalty. Except I never actually withdrew the money. It’s still in my rollover individual IRA. So am I still subject to a 10% penalty? Is it my responsibility to report this to the IRS or will they automatically send me a penalty notice?

What other tax implications could this transaction have? I know that I underestimated my taxes for last year so I’ll have some penalties. Is there anything else I should be aware of? I sent a letter to the attorney letting him know I expect the company to resolve this but have not been specific in requesting what the resolution should be. What a mess.

 

[pb4uski]

This link seems relevant... similar situation where an excess contribution occured that was not the employee's fault: https://www.irahelp.com/forum-post/...ns-under-employee-plans-compliance-resolution

My advisory client (age 54) did a direct rollover of $13,000 from an old 401K to his IRA in August 2019.

In January 2020, client received a letter from his old company that $4,000 of this amount failed the non-discrimination testing and must be returned to him.

The full $13,000 was invested in his IRA account back in August 2019 and still remains invested there.

The client received two Form 1099R's: One for $9,000 showing Code G (Direct Rollover), and a second one for $4,000 showing Code E (Distributions Under Employee Plans Compliance Resolution System).

The client must advise the IRA custodian that 4000 was not eligible for rollover and must be treated as an excess regular IRA contribution. The IRA Custodian will then calculate the earnings allocated to the 4000 and distribute the 4000 plus the earnings to the client. As such, only the earnings will be taxable and subject to penalty, but this tax and penalty must be reported on client's 2019 return because the excess IRA contribution was made in 2019. There is no double tax, as long as the IRA custodian understands this is the removal of an excess contribution.

The only tax on the 4000 is from the 1099R coded E and there is no penalty on this. The earnings will be taxed and subject to penalty. For the return of the IRA contribution, the 1099R will be issued next January with code P1. P means taxable in 2019, not 2020.

 

[pb4uski]

Sounds like they are trying to self-correct the error.... but one aspect of self-correction is that they "Make any necessary corrections to put the participants in the position they would have been in if the error had not occurred."

https://complianceadministrators.com/qualified-plan-correction-programs/

In your next letter to the company's attorney you might say that if you don't get a resolution that is acceptable that you will file a complaint with the IRS that the plan did not properly correct its error... that should get their attention and a response I would think.

 

[Ready]

Sounds like they are trying to self-correct the error.... but one aspect of self-correction is that they "Make any necessary corrections to put the participants in the position they would have been in if the error had not occurred."

https://complianceadministrators.com/qualified-plan-correction-programs/

In your next letter to the company's attorney you might say that if you don't get a resolution that is acceptable that you will file a complaint with the IRS that the plan did not properly correct its error... that should get their attention and a response I would think.

Very helpful, thank you!! It sounds like at a minimum they are required to pay reimburse me for the 10% penalty. At question is whether I’m entitled to reimbursement for any fees I have to pay a professional accounting firm to correct all of this, since it would appear I have to amend prior year’s returns to correct the error.

 

[cathy63]

What's the year on the 1099-R you received from Fidelity today? That's the return that's affected, so if it's a 2020 1099-R and you haven't filed yet, you might not need to amend.

 

[Ready]

What's the year on the 1099-R you received from Fidelity today? That's the return that's affected, so if it's a 2020 1099-R and you haven't filed yet, you might not need to amend.

It's 2020. So they are reclassifying the income as 2020 income? Is that legitimate?

 

[cathy63]

It's 2020. So they are reclassifying the income as 2020 income? Is that legitimate?

Yes, I think it's allowed. It's similar to if you are in a plan that fails non-discrimination testing and they have to return some of your contributions. That money is taxed as income in the year you receive it, not the year you deferred it.

 

[Ready]

Yes, I think it's allowed. It's similar to if you are in a plan that fails non-discrimination testing and they have to return some of your contributions. That money is taxed as income in the year you receive it, not the year you deferred it.

OK, that makes sense. Am I required to actually withdraw the money from the IRA though? Thanks so much for your help with this!

 

[pb4uski]

I think this is starting to make sense.

When you left in 2017, you were due $20k of severance. Severance pay can't be contributed to a 401k. Your employer (HR person) erred by asking you if you wanted that pay deferred, you agreed not knowing that the severance could not be deferred and the employer then erroneusly allowed the $20k to be contributed to your 401k.

In early 2020, your employer notified you that their error had been detected as a result of an audit of their 401k plan.

In the meantime, you had rolled over your employer 401k, including the $20k, to an individual IRA at Fidelity.

The company was unresponsive to your queries on the issue and notified Fidelity of the overcontribution and based on that Fidelity issued you a 1099-R for $21k with a distribution code E.

What you might do if you have a lot of your tax return together is to input the $21k of income from the 1099-R with the code E and see how it changes your taxes and if the software includes any 6% overcontribution or 10% early withdrawal penalties... and compare the overall tax impact to what it would have been if you had recognized that $21k of income in 2017... and see if the damage is enough to chase your former employer for.

And then course, get the $20k plus growth out of the account. Your OP mentions $20k and the 1099-R is $21k... is the difference the growth or just a difference in rounding?

 

[Ready]

I think this is starting to make sense.

When you left in 2017, you were due $20k of severance. Severance pay can't be contributed to a 401k. Your employer (HR person) erred by asking you if you wanted that pay deferred, you agreed not knowing that the severance could not be deferred and the employer then erroneusly allowed the $20k to be contributed to your 401k.

In early 2020, your employer notified you that their error had been detected as a result of an audit of their 401k plan.

In the meantime, you had rolled over your employer 401k, including the $20k, to an individual IRA at Fidelity.

The company was unresponsive to your queries on the issue and notified Fidelity of the overcontribution and based on that Fidelity issued you a 1099-R for $21k with a distribution code E.

What you might do if you have a lot of your tax return together is to input the $21k of income from the 1099-R with the code E and see how it changes your taxes and if the software includes any 6% overcontribution or 10% early withdrawal penalties... and compare the overall tax impact to what it would have been if you had recognized that $21k of income in 2017... and see if the damage is enough to chase your former for.

And then course, get the $20k plus growth out of the account. Your OP mentions $20k and the 1099-R is $21k... is the difference the growth or just a difference in rounding?

That pretty much sums it up. What still doesn’t make sense to me though is if Fidelity made the decision to send me the 1099-R showing a distribution, why didn’t they actually send me the distribution?

 

[statsman]

Any possibility this amount has been converted into a non-deductible IRA?

 

[cathy63]

That pretty much sums it up. What still doesn’t make sense to me though is if Fidelity made the decision to send me the 1099-R showing a distribution, why didn’t they actually send me the distribution?

Who is the custodian for your old employer's plan? Any chance that was also Fidelity, maybe their NetBenefits system? I'm wondering if the 1099 is from the employer plan rather than the rollover IRA.

Either way, I think you do need to call Fidelity and discuss it with them.

edit: OK, I see back in post #1 that you said both the 401k and IRA were at Fidelity. I think Fido's right hand and left hand are not talking to each other, and the 1099 you got is probably from the 401k, meaning that the IRA people don't know anything about it. You would need to withdraw the excess contribution from the rollover IRA yourself. You might need to go up the ladder with the team there to make sure it gets coded properly. You don't want to get another 1099 for tax-year 2021 showing the withdrawal.

 

[Dan32]

In 2 separate occasions when rolling over 401Ks, I had both pre-tax and some after-tax contributions. The after tax was the result of over contributions over the years which was taxed (correctly) in the year the contribution was made. I believe I was given the option of contributing less or continuing with the same % of salary contribution and paying taxes on the overage. But when I rolled this over I was allowed to roll the after tax portion into a Roth IRA, I think this should have been allowed in your case if there were excess (after tax) contributions in your 401K. One of these cases was a transfer from a Fidelity 401K to a TDA IRA and Roth IRA.

 

[Ready]

I spent three hours on the phone with Fidelity this morning getting bounced around between their 401K and IRA departments. The various responses I got were to 1) talk to my accountant, 2) Call the employer to discuss it. I had to press really hard before I finally got a call back from a manager.

When I spoke to the manager, I posed a simple question: How can Fidelity issue me a 1099-R showing a $21,000 distribution when it did not actually distribute any money? She agreed that is a legitimate question that Fidelity needs to answer and promised to research it and get back to me within five business days.

I also have a conference call with a tax accountant this afternoon to see if they can offer any additional guidance. I believe Fidelity made the error by agreeing to issue a 1099 without a corresponding distribution. They are claiming they simply did what the company directed them to do, but I reminded them that Fidelity is the record keeper and is responsible for ensuring their transactions are in compliance with 401K regulations.

 

[pb4uski]

It sounds like that the employer/401k reported that to Fidelity that it had made an error in letting you defer severance income and Fidelity issued the 1099-R is to offset the fact that you were allowed to make a 401k contribution in 2017 for severance income that was not eligible to be deferred. IOW, if you have your paystub after the severance payment then the severance payment was included in gross earnings but also as a 401k deduction so your W-2 erroneously showed $0 of income relating to the severance where it should have shown $20k of income and $0 401k deduction. The 2020 1099-R corrects that error (at least for the contribution part).

Go back to posts #87 and #88. I think that your situation is very similar to the situation in post #87 and that the resolution will be similiar.