Benefits Blunder: IRS Notice on Retirement Plan Overpayments

What should you do if you mistakenly pay out too much for one of your employer-provided benefits, such as your retirement plan?

Plan sponsors have had some uncertainty about that ever since 2022.

That’s when Congress passed the Secure 2.0 Act, and the law added two new sections to the Internal Revenue Code (IRC). They were:

• Sec. 414(aa), which covers special rules applicable to benefit overpayments, and
• Sec. 402(c)(12), which concentrates on transfers to eligible retirement plans.

Thanks to recent IRS guidance, plan sponsors now have reassurance as they work to make sure their benefits programs adhere to the IRC.

IRS Starting Point: The Definition

Notice 2024-77 provides details in a question-and-answer format.

First, the IRS notice gives the definition of “inadvertent benefit overpayments” for purposes of sections 414(aa) and 402(c)(12).

It’s an eligible inadvertent failure that occurs due to a payment made from a plan that exceeded the amount payable under the terms of the plan.

Similarly, it may be a payment that’s gone beyond a limit provided in the IRC or regulations.

It can even be a payment made before a distribution is allowed under the IRC or the terms of the plan.

Look at the Benefits Big Picture

A plan sponsor can try to recoup the amount from a participant or beneficiary. In the past, if that effort fell through, the plan sponsor needed to make a corrective payment to fix the overpayment.

Now, failing to make a corrective payment won’t affect your retirement plan’s satisfaction of Sec. 401(a) and Sec. 403 of the IRC.

A word of caution for plan sponsors: Other sections of the IRC should be considered.

For example, perhaps a profit-sharing plan is one of your company’s benefits. Say the reason one plan participant received an inadvertent benefit overpayment was because of an incorrect allocation of a profit-sharing contribution under the plan. Meanwhile, another plan participant came up short. So, a corrective payment may ultimately be needed to fix the problem of the benefit underpayment.

Retirement Plan Rollovers

The IRS guidance also explains some tax implications of an inadvertent benefit overpayment.

Let’s say your company issued such an overpayment and didn’t recoup the funds from the participant or beneficiary.

If the individual rolls over the overpayment pursuant to a direct or 60-day rollover, then the tax-favored status of the amount is retained, as spelled out in IRS Notice 2024-77.

If a payment is transferred from the original plan to a second plan, the money is later recouped and the amount is transferred back to the original plan, they’re both eligible rollover distributions.

This can occur, regardless of the terms of your benefits plan.