SOLUTIONS IN A FLASH – RETIREMENT PLAN CORRECTION SOLUTION:
OOPS! WE DID IT AGAIN – CORRECTING OVERPAYMENTS IN DEFINED BENEFITS
PLANS AFTER SECURE 2.0

by: Jessica M. Hobbs, Esq.

Britney, a retired singer and superstar, owns and operates Lucky Records (the “Company”), a record company in Los Angeles with 44 employees. The Company sponsors the Lucky Records 401(k) Profit Sharing Plan (the “PS Plan”) to help its employees save for retirement. As an added benefit, the Company also sponsors the Lucky Records Pension Plan (the “DB Plan) for its salaried employees. (If you are a frequent reader of Solutions in a Flash, you may remember Britney from our earlier newsletter, which is available here.) Just a few months ago, Britney learned that, after her former HR VP’s misguided decision to fire their TPA, the Company presumably failed ADP testing due to significant deferrals by its record executives, who were deemed Highly Compensated Employees (“HCEs”). The Company distributed refunds as a result. Thankfully, and in true form to its name, the Company got lucky. Someone in the Benefits Department listened to a Ferenczy Benefits Law Center webcast on ADP testing and learned that several of the previously identified HCEs were actually Non-Highly Compensated Employees (“NHCEs”) under the “top-paid group” rule, and refunds had been issued to the employees in error. Britney engaged her good friend and former TPA, Justin, who jumped right in to assist.

Unfortunately, after working through the necessary corrections for the PS Plan, Britney remembered that the Company used the same data for its DB Plan’s administration. In that plan, there is a benefit formula that is different for the HCEs than for the NHCEs (all of which is tested for nondiscrimination, of course).  Britney asked the Benefits Department to look at the data once again. They confirmed that the same issue is present in the DB Plan that they saw previously in the PS Plan. The wrong people were classified as HCEs, so the nondiscrimination testing was incorrect.  In addition, some of the people incorrectly classified as HCEs terminated employment and received benefits that were inflated, because those NHCEs were not entitled to the plan’s HCE benefit formula.

Britney once again calls Justin. “Justin,” Britney begins, “Please don’t hold it against me, but I think we have another overpayment problem … this time, in our DB Plan. Hit me with the facts one more time, but this time tell me how we correct the issue for a pension plan.” Justin, who already had this potential issue on his radar, eagerly begins walking Britney through what she’ll need to do this time.

I (Can’t) Run Away: Addressing Overpayments

Having gone through a similar situation recently, Britney understands that this error cannot simply be disregarded. The Internal Revenue Service (the “IRS”) has outlined a specific process that plan sponsors must follow to correct plan errors. As with the PS Plan, the issue here is that an overpayment has occurred: participants received benefits to which they were not entitled. The DB Plan’s administration must now be properly corrected to avoid compliance and qualification issues.

Justin asks Britney the same questions he asked previously to determine the scope of the situation. Who are the affected participants? Do the affected participants still have access to the money and are they willing to return it to the DB Plan? This information permitted Justin to have the plan’s actuary recalculate the amount that should have been paid to the terminated employees.

Justin reminds Britney that, while the IRS generally requires the DB plan to request repayment from affected participants, under SECURE 2.0. she may be able to choose not to pursue recovery if the overpayment was a mistake, or an “inadvertent benefit overpayment” (“IBO”). Justin also shares that, as the DB Plan is affected this time, things are more complex, but there are a few additional options for correction.

The Answer: Following the Guidance

Justin begins advising Britney on corrections options for the pension plan overpayments. He explains that, while some of the corrections options are the same as they would be for a defined contribution plan, there are correction avenues available exclusively for defined benefit plans.

Option #1: Corrective Amendments

First, depending on the situation, a defined benefit plan can correct an overpayment by adopting a retroactive amendment to increase the overpaid participant’s benefit to match what was paid. The retroactive amendment ensures that, operationally, the Plan terms match the actual practice that led to the overpayment. Justin explains that a retroactive amendment is most useful when it results in an increase in benefits, rights, and features to participants, but may only be used if the result would not be discriminatory or violate the Internal Revenue Code (the “Code”). As the participants in this case are NHCEs, increasing their benefits will not result in discrimination, so it may be the easiest and best solution.

Option #2: Don’t Seek Repayment from the Participant

Second, Justin reiterates that if the overpayment was an IBO, Britney is permitted, but not required, to just let the overpaid participants keep the paid funds.

Britney may not let the participants keep the overpayment if it is not an IBO.  In particular, the plan must pursue repayment when:

– The overpayment was made to a “disqualified person” under Code section 4975(e) or an owner-employee of the plan sponsor. Disqualified persons include fiduciaries, 10% owners of the employer, officers, directors, HCEs earning more than 10% of the Company’s yearly wages, and certain family members of those individuals; or

– The overpayment results in a violation of the Code’s compensation limit (Code section 401(a)(17)) or the legal limits on plan benefits (Code section 415(b)). In other words, the benefit paid was legally impermissible.

Justin also reminds Britney that there is a $250 “de minimis” rule for overpayments. If the extra amount paid to the participants is not more than $250, no correction is required at all.

Justin encourages Britney (and her colleagues reading about this situation) to review her notes from their last conversation about the PS Plan, for more detailed information on recovering overpayments that are IBOs. (These notes are in the Solution that is referenced above.)

Option #3: Seek Repayment from the Participant

Finally, if Britney wishes to recoup the overpayments from affected participants (or their beneficiaries), she must remember that recovery is limited by the following:

1. Recovery may not be sought from a surviving spouse or beneficiary.

2. There can be no threats of litigation against a participant during the recovery process, unless it is reasonably likely that the amount recovered from the participant will be greater than the cost of recovery. Britney should use discretion here and consider whether litigation is necessary and worthwhile.

3. The overpayment may not be referred to a collection agency unless there is a final judgment or settlement that authorizes recovery that the participant rejects or ignores.

4. No interest or fees may be sought on the overpayment.

5. The overpayment must have occurred within three years of the participant or beneficiary being notified in writing about the error.

6. If the participant is receiving periodic payments from the plan (such as an annuity), the overpayment may be recouped from future payments, but there are limitations on how that works.

Special DB Rules and Opportunities

Justin then explains that some special rules apply to defined benefit plans.

If the participant does not repay the overpayment from a defined benefit plan (either because he or she refuses or because the employer decides not to pursue repayment), the employer may be required to make a contribution to the plan to make the plan “whole.”  This may not mean that the employer must deposit the full amount of the overpayment. There are two special methods for determining any required employer contribution, but neither is available if the overpayment is not an IBO.

The “funding exception correction method” may be used only when the plan does not seek recoupment from the participant. Under this exception, no payment by the employer is required. However, this method may be used only if:

– The participant is receiving periodic payments, future periodic payments are reduced so that the overpayment does not recur. For example, if a participant elected lifetime payments, and was paid $150 per month, rather than the proper $100 per month, then future payments must be reduced to $100 per month.

– The plan is a single employer plan and subject to Code section 436, the AFTAP (a mathematical measurement of plan’s funding level, performed by an actuary) is at least 100%. Different rules apply to multiemployer (i.e., union) plans.

Alternatively, the “contribution credit correction method” is also available. This method, which also requires actuarial assistance, is generally used when a plan is underfunded and cannot use the funding exception correction method. Unlike the funding exception correction method, recoupment may be sought from the participant. But the amount to be recovered may not have to be the full overpayment.

Under this method, the actuary determines if there is a “funding credit balance.” If there is, that balance may be used to offset the amount to be recovered from the participant or the employer’s additional contributions needed to get the plan back on track. (Justin then warns Britney: “These calculations and technical terms make sense only to actuaries!  We’ll talk to the actuary to see what she says and then just go with the flow.  Getting too into the weeds on this stuff is really toxic.”)

If the Company chooses to recover overpayments from affected participants using the contribution credit method, the participants must be allowed to choose whether they will repay it as a single sum payment, through an installment payment (over at least a 5-year period), or by adjusting future benefit payments (assuming the entire benefit has not yet been paid out). Justin emphasizes that Britney needs to work closely with him to ensure that the calculations of the required repayment are completed correctly.

Don’t Hang Up: A Final Word

A very relieved Britney thanks Justin for his willingness to assist once again. Justin tells Britney that he’s always happy to help, but reminds her that she should still reach out to legal counsel to assist with the correction. Britney, having heard great things about Ferenczy, makes a note to call them. Britney also informs Justin that the Company replaced its previous HR VP, Kevin.  “And,” she says, “I’m totally convinced now that we need a TPA to take care of us.  I appreciate all your help. Be sure to send me your engagement letter, so that we can get back to relying on you all the time.” She winks at him and says, “Come on Baby, One More Time.”

Friends of Britney (and Ferenczy), should you find yourself in need of assistance with a correction, please contact us. We are, after all, your ERISA solution!