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401k Excess Employer Match - Penalty

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Latest post Tue, Nov 8 2016 2:49 PM by Drew. 8 replies.
  • Mon, Nov 7 2016 7:44 PM

    • ChuckSVA
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    401k Excess Employer Match - Penalty

    My employer has just notified me that they made an error for 12 years by contributing more employer match than allowed by law.  This affected me for 4 of those years, all of which the tax filing deadline has passed.  I left the company several years ago and rolled the 401k into a personal IRA.  The company requires that i withdraw the overpayment from the IRA (including projected gains.)  Best I can tell, this is seen as a distribution from the IRA and is subject to tax, plus a 6% penalty PER YEAR that it has not been repaid, plus a 10% penalty since I am under 55.

    Note that I have made nothing on this - the over payment and any gain has to be repaid - and I will be subject to taxes (on money that I don't keep), and penalties all due to the employer's error.  The employer has provided scant information and I am guessing would have a large liability of they are required to reimburse everyone affected for their penalties and fees.

    The money that was contributed did exceed the amount allowed so I see no choice but to pay it back.  However, i have 2 questions.

    1.  Has anyone seen this before and is there anyway of avoiding the penalties and taxes?

    2.  Is there any legal precedent that the company should be liable - short of an expensive (and I am sure aggressively defended) lawsuit?

  • Mon, Nov 7 2016 10:32 PM In reply to

    Re: 401k Excess Employer Match - Penalty

    In this case you won’t have to pay the 10% early withdrawal tax (penalty). However, you would include the distribution in income and pay the tax on that distribution. The IRS has a page on its site that explains how excess contributions by an employer should be corrected: fixing excess plan contributions.

    Do I understand correctly that the employer is requiring you to return the entire distribution you receive to the employer. Has the employer explained why it is requiring that money back?

  • Tue, Nov 8 2016 3:29 AM In reply to

    • ChuckSVA
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    Re: 401k Excess Employer Match - Penalty

    Yes, you understood it correctly.  Apparently the IRS has a compensation limit after which no futher company matching contributions can be contributed to a retirement account.  I guess my former employer (a $10B Fortune 500 company) didn't know this eitherand contributed excess matching contributions to those whose compensatione exceeded the limit for 12 years.  (quite unbelievable to me and quite a show of incomptence that it coud go undetected that long.  And, while they haven't stated it some current employees have suggested that the errors, if not corrected, places them at risk of losing the tax-exempt status of their plan.)  The first letter I received had few details other than "we overpaid, please pay this amount in 60 days."  I called and asked for details by year, and followed with a letter and no response.  Then 60 days letter a similar letter arrived by registered mail.  This time the phone call got me some details but only verbally. 

    So they put more in my account over a 4 year period than was allowed by law - and this is to be returned to their retirement plan PLUS the earnings projection of what it may have earned since.

    Paying it back doesn't concern me - as it was an error and violated IRS rules - I am concerned that I have to pay taxes and a penalty when I have made no mistake nor have I benefited. 

    This is also different than most of the over-payment sitiuations I have read about in that it was completely an employer error of the matching portion and not an employee error.  I can't find any similar examples on the IRS website.

  • Tue, Nov 8 2016 4:58 AM In reply to

    • Drew
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    Re: 401k Excess Employer Match - Penalty

    That is not my lay read of the IRC issues .   The write up addressed by another says the correction withdrawal is paid to YOU , the participant .

    IF the employer overcompensated you...I'd want to see a very careful legal analysis under applicable state law where you have a duty to repay being supposedly overpaid ...before I sent them a dime ....

     

     



  • Tue, Nov 8 2016 7:24 AM In reply to

    • Drew
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    Re: 401k Excess Employer Match - Penalty

    I can see some math logic as to you need to distribute your personal pro rata share of the overpayment to yourself and pay the income taxes ( no 10% penality )  ..on just that portion ..buts that not even close to what you describe the past employer seeks . 



  • Tue, Nov 8 2016 7:31 AM In reply to

    Re: 401k Excess Employer Match - Penalty

    ChuckSVA:

    Paying it back doesn't concern me - as it was an error and violated IRS rules - I am concerned that I have to pay taxes and a penalty when I have made no mistake nor have I benefited.

    As the page I linked earlier explains, you won’t have to pay the penalty as a result of correcting the employer’s mistake. It does say you would take the distribution into income, but in that example there is no mention of the employee having to pay back the employer. If your employer is entitled to the money back and you repay it then there is no income and you would not have to pay tax on it. I would want to be sure that the employer was entitled to get it back before sending the employer a check, however.

    ChuckSVA:
    This is also different than most of the over-payment sitiuations I have read about in that it was completely an employer error of the matching portion and not an employee error.  I can't find any similar examples on the IRS website.

    The page I linked earlier has an example with exactly that situation: the error was entirely the employer’s. That’s why I provided it.

  • Tue, Nov 8 2016 1:03 PM In reply to

    • ChuckSVA
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    Re: 401k Excess Employer Match - Penalty

    Yes but ... in that example the excess employer contributions that the employee was not entitle to and that had to "come out" of the retirement plan, were forfeited by the employee and went back to the "plan" for future matching.

    In my case the 401k has been rolled to an IRA so it is no longer a part of the plan.  It has to come out of the IRA and be returned to the plan (or so the employer suggests) via a payment to them.

    The IRA people at FIdelity tell me that ANY thing coming out of the IRA is a distribution and is treated as such.  So... to get money out of the plan it requires a distribution and associated taxes and penalties.

    Some suggest the distribution comes to me and I can pay taxes and penalties and keep what remains.  However, that does not do what the example suggests by returning excess contributions to the plan (former employer).

    If a distribution is made directly from the IRA to the Plan, Fidelity still issues a 1099 reporting the distribution and it triggers (I think) associated taxes and penalties.

    Some suggested to not pay the penalties and when/if the IRS bills me, then explain and petition for a waiver as not-my-fault and I benefited in no way.

    I have no idea which is best and least risk.  Still researching.  Any more advice is much appreciated.

  • Tue, Nov 8 2016 1:24 PM In reply to

    • Drew
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    Re: 401k Excess Employer Match - Penalty

    So far there is no basis to assume you have any duty to lift a finger to cure any of the prior employers problems or those of the plan sponsors ......now you might be tax smart to distribute your pro rata excess share to yourself and pay any of the income taxes on just that share .....and sort out the VA income tax ramifications as well....

    IF there is law on point as to your duty to do it way employer suggests.....invite employer to lay it all out crystal clear in writing 

    I think employer is dreaming .....

     



  • Tue, Nov 8 2016 2:49 PM In reply to

    • Drew
      Consumer
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    • Joined on Thu, Mar 30 2000
    • PA
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    Re: 401k Excess Employer Match - Penalty

    there may be an annual 6% surtax in there someplace on excess contribution......beyond me .



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