We see it happen on a regular basis. Usually as the result of a miscommunication, a retirement plan sponsor makes an erroneous contribution to the plan. This can cause unintended and unwanted consequences, often including nondeductible and/or disallowed amounts. What can be done?
Contributions to a qualified retirement plan are generally irrevocable. In this article we’ll focus on single-employer plans; there are separate but similar rules for multiemployer plans which we will not include here.
Under ERISA Section 403(c), plan assets are “for the exclusive purpose of providing benefits to participants in the plan and their beneficiaries and defraying reasonable expenses of administering the plan.” Diverting funds could compromise the accrual and/or security of benefits. However, in specific instances, contributions may be returned to the plan sponsor if there is a mistake of fact contribution.
While the IRS has not explicitly defined a mistake of fact contribution, it is different than a non-deductible contribution. Typically, mistake of fact instances include a disallowance of deduction, failure of the plan to initially qualify under 401(a), or mathematical or typographical errors. Ultimately, a private letter ruling may be the best method to determine if a mistake of fact contribution occurred.
If there is a mistake of fact contribution, the contribution must be returned to the plan sponsor within 12 months of the mistake. Earnings on the contribution are ignored in the reversion, but losses must be recognized. If the plan failed to initially qualify under 401(a), all assets are returned to the employer.
There is a de minimis rule in the case of a defined benefit plan making quarterly contributions. If there is a disallowance of deduction of less than $25,000, IRS approval is not required. However, an explanation of this specific instance must be included as an attachment to the Form 5500 filing. It is also important to check the terms of your plan document regarding mistake of fact contributions.
If the money is stuck in the plan, and an excess contribution occurs, what are our options if we cannot revert the money to the plan sponsor?
Let’s look at an example of an individual who is not yet age 50 and thus not eligible for catch-up contributions, and who earned $300,000 in 2023. This individual defers $2,000 per month to their 401k plan. Their employer contributes 15% of pay with every monthly paycheck (sounds like a generous employer). At the end of 2023 the employee has deferred $24,000, $1,500 over the 402(g) deferral limit. The employer has contributed $45,000, making the total contribution of $69,000, well in excess of the 415(c) limit of $66,000. What can they do?
The excess deferral can be corrected by distributing $1,500 to the participant (with earnings), so long as it is done so by the tax filing deadline. But what if the deferral is not correct by the tax filing deadline? Or what if the plan limited deferrals to 5% of compensation? Would the IRS consider this a mistake of fact contribution? The answer depends on the facts and circ*mstances surrounding the situation. In the case of the plan limiting deferrals to 5% of compensation, would an 11(g) corrective amendment be a better approach?
Let’s assume the excess deferral was corrected by distributing $1,500 to the participant. We are still $1,500 over the 415(c) limit. This amount (with earnings) can be allocated to a suspense account. The money in the suspense account can then be used to make contributions for other employees in the current or future years, or can be reallocated to the same participant in future years. Alternatively, if some of this contribution was deposited in 2024 instead of 2023, the contribution could be reallocated to 2024 without making an adjustments to the participant’s account.
While the information in this article provides a specific example, it is important to note that every situation is different. There may be additional tax factors to consider as well. If you have made an excessive contribution to a retirement plan, it is wise to consult with ERISA council, and if applicable, your plan’s actuary and CPA to determine your best course of action.
Jeffry Lamb, EA, MAAA is owner and consultant of Independent Actuaries, Inc.
