Congress issued guidance on correction of plan errors through SECURE 2.0. The source of the guidance was unexpected, as guidance on plan administration has typically been left to the purview of the IRS. Section 301 of the Act addresses correction of plan overpayments and amends sections of both ERISA and the Code. These additions codify the IRS’ established correction principles and create new requirements, but the additions also create a potential conflict between plan qualification and plan administrator fiduciary duties.
Prior plan correction guidance was issued by the IRS through the Employee Plans Compliance Resolution System (EPCRS). EPCRS is generally updated every few years, with the most recent version being published in 2021 (Revenue Procedure 2021-30). In its newest edition, EPCRS provided updated procedures for correcting overpayments. Overpayments are defined by EPCRS as payments to a plan participant or beneficiary that are in excess of the amount payable under the terms of the plan (e.g., error in calculating participant’s benefit) or exceed a limitation provided in the Code or regulations (e.g., benefit distributed in excess of the 415 annual benefit limit).
Recovery of overpayments from affected recipients is not always required by EPCRS. Plan administrators may often use discretion in seeking overpayments. We typically see plans not seek overpayments when the error was caused by the plan administrator or where correction does not require a contribution from the participant or the plan sponsor (e.g., an overpayment in a fully-funded defined benefit plan). Regardless of the method of correction, correcting overpayments under EPCRS requires a written notice to affected overpayment recipients that such overpayments are classified as taxable and are not eligible for rollover. With SECURE 2.0, Congress codified the principle that failure to recover inadvertent overpayments from the recipient would not be a breach of fiduciary duty under ERISA or a reason for plan disqualification under the Code.
In addition to the codification of current principles, Congress amended ERISA to now prohibit recovery of overpayments, making it a breach plan administrator’s fiduciary duty, if:
- Overpayments are sought from any beneficiary;
- Recovery is accompanied by threats of litigation or made through a collection agency or third party;
- Interest or fees are sought with recoupment of overpayments; or
- The first overpayment occurred more than 3 years before the participant or beneficiary is first notified in writing of the error.
The Code was also amended to now require recovery of overpayments from a recipient when the plan overpayment was due to violating a limit imposed by section 401(a)(17) or 415 of the Code (i.e., violations of the annual compensation or annual benefit limits).
With the additions of SECURE 2.0, plan administrators could find themselves in the position where they are both required to correct a plan overpayment to maintain plan qualification status under the Code, but are prohibited from correcting the same overpayment without breaching their fiduciary duties under ERISA. For example, if a plan made annuity distributions in excess of the section 415 limit for the past 5 years, the plan would have an obligation under the Code to seek recoupment of the overpayment from the participant, but because the first overpayment occurred more than 3 years before the participant could be notified of the error, it would be a breach of duty under ERISA to seek repayment from the participant. The plan administrator would have to decide between satisfying the requirements of the Code or ERISA.
Lastly, the section of the Code permitting rollovers was amended so that now an overpayment transferred to another plan for which recoupment is not sought will be treated as having been paid in an eligible rollover distribution. Similar favorable tax treatment was not provided for overpayments paid directly to employees. EPCRS still provides that the plan sponsor must notify the overpayment recipient that the overpayment is not eligible for favorable tax treatment, and, specifically, is not eligible for tax-free rollover. We anticipate future guidance on this issue, as the written notice requirement needs to be amended for the new distribution rule to other plans. It will be interesting to see if the different tax treatment, dependent on the destination of the overpayment distribution, was intentional, or if EPCRS will be amended or supplemented by future guidance.
These changes to the overpayment correction procedures are effective as of the date of enactment of SECURE 2.0 (December 29, 2022). We will continue to monitor this topic for future guidance, and expect the new requirements will impact the next version of EPCRS. In the meantime, if you have any questions regarding corrections or any of the provisions in SECURE 2.0, please contact any of the attorneys in our Employee Benefits group.
