IRS Releases Guidance on Overpayments from 401(k) Plans

On October 15, 2024, the IRS released Notice 2024-77, addressing new rules regarding corrections of overpayments from retirement plans (including 401(k) plans) under the SECURE 2.0 Act (SECURE 2.0). The Notice helps to clarify those circumstances in which plan sponsors may correct certain inadvertent benefit overpayments made to plan participants, without necessarily seeking to recoup those amounts or make corrective payments. Prior to SECURE 2.0, plan sponsors were usually required to attempt to recoup such overpayments or make corrective payments in order to avoid potential plan disqualification.

What did SECURE 2.0 Change?
Effective as of December 29, 2022 (see our blog for details), SECURE 2.0 generally changed the way plan sponsors may attempt to correct inadvertent benefit overpayments by providing that, upon discovery of an overpayment, sponsors may:

• Reduce the participant’s or beneficiary’s future benefit payments to the correct amount under the terms of the plan;
• Seek to recover the overpayment from the person responsible for the overpayment, subject to certain conditions; or
  
  
• Choose not to: seek to recoup the overpayment; make any adjustment to the participant’s or beneficiary’s future benefit payments;  or make any corrective payments (unless otherwise required — see below).

SECURE 2.0 prescribed new rules that plan sponsors must follow if they do decide to seek recoupment (for example, sponsors generally may not threaten litigation or engage a collection agency in an effort to recover an overpayment, or recoup overpayments following the death of a spouse or other beneficiary). The legislation also included special rules regarding rollovers of overpayments and other related matters.

Highlights of Notice 2024-77.
The Notice focuses primarily on the following areas:

• The definition of “inadvertent benefit overpayment”;

• The elimination of the prior obligation to attempt to recoup inadvertent benefit overpayments, or make corrective payments, subject to specified exceptions; and

• Rollovers of inadvertent benefit payments.

These are discussed in more detail, below.

Definition of “Inadvertent Benefit Overpayment.”
Generally stated, Notice 2024-77 defines “inadvertent benefit overpayment” as a payments made to a plan participant that exceeds the amount payable under either the plan’s terms or the applicable provisions of the Internal Revenue Code (Code), or is made before a distribution is permitted under the Code or under the terms of the plan. Overpayments can include both lump sum distributions and periodic payments (such as annuities).

“Inadvertent benefit overpayments” do not include:

• Overpayments made to “disqualified persons” (individuals directly connected to the operation of the plan, such as a fiduciary, an employer or a service provider; or to owner-employees); or

• Plan payments made under EPCRS (as defined below) to correct an unrelated plan qualification failure.

Elimination of Prior Obligation to Recoup Overpayments or Make Corrective Payments.
As previously stated, SECURE 2.0 generally removed the obligation on the part of plan sponsors to attempt to recoup inadvertent benefit overpayments. Similarly, corrective payments are generally no longer required, with certain exceptions.

• Recoupment Under EPCRS Still Permitted. Notice 2024-77 clarifies that most inadvertent benefit overpayments also constitute “eligible inadvertent failures” that employers generally may choose to self-correct under the IRS’ Employee Plans Compliance Resolution System (EPCRS), as expanded by SECURE 2.0 (see our blog for more information about expanded EPCRS). If recoupment under EPCRS is chosen, the Notice identifies several sections of the EPCRS Revenue Procedure that are not applicable under these circumstances (for example, sections requiring corrective payments).

• Corrective Payments Still May Be Required in Certain Cases. Corrective payments for inadvertent benefit overpayments still may be necessary in certain circumstances; for example:
  • If an inadvertent benefit overpayment results in an underpayment to another participant (in which case a corrective payment would be needed to make the other participant whole in accordance with general correction principles);
  • To avoid an impermissible forfeiture of a participant’s vested benefit; or

• • If an inadvertent benefit overpayment results in a secondary failure involving the Internal Revenue Code’s compensation, benefits, or contribution provisions, a corrective payment under EPCRS would need to be made if the overpayment is not recouped.

Rollovers of Inadvertent Benefit Overpayments.
If any portion of an inadvertent benefit overpayment is not recouped, and it would have qualified as an “eligible rollover distribution” (as defined below) had it not been an overpayment, the amount is treated as an eligible rollover distribution.

• • On the other hand, if the employer seeks recoupment and the overpayment is returned to the original plan, both the original plan and the receiving plan may treat the amount as an eligible rollover distribution, regardless of the terms of either plan.
  • Any amount for which recoupment is sought but not obtained is not treated as an eligible rollover distribution, and the plan sponsor must notify the participant or beneficiary that the amount not recouped will not receive favorable rollover tax treatment.
  • An “eligible rollover distribution” is, generally stated, a distribution from one qualified retirement plan that is eligible to be rolled over or transferred to another eligible retirement plan.

Impermissible Plan Amendments.
The Notice also provides that corrective plan amendments made to increase past, or decrease future, benefit payments to affected participants may not cause the plan to violate any other qualification requirement under the Internal Revenue Code.

Effective Date / Reliance.
Notice 2024-77 is effective as of October 15, 2024. For periods prior to the effective date, plan sponsors may rely on a good faith, reasonable interpretation of the relevant statutory provisions.

DISCLAIMER:

This article is not meant to offer a detailed analysis of Notice 2024-77 or the legal rules relating to payments from 401(k) plans, rollovers, plan corrections, or other requirements applicable to 401(k) plans or other types of retirement plans (such as defined benefit plans, governmental plans, individual retirement accounts or 403(b) plans), or health and welfare benefit plans. As always, be sure to consult with your own ERISA attorney or other professional advisor for individualized advice with respect to your plan’s unique situation.