IRS Clarifies When Retirement Plan Overpayments Can Be Rolled Over

“If employer overpaid payments in a stream of monthly income (like an annuity), it can reduce the future payments by up to 10% to recover the excess on past payments,” Iwry said. “The limit reflects concern that innocent payees might have gotten accustomed to the larger amount.”

Defined benefit plans “have some special variants on the rules because [an] employer has funding obligations to a DB that might automatically increase, thereby preventing the remaining participants from being short-changed because earlier retirees got too much,” Iwry added.

“The various forms of relief apply only if the error was inadvertent so the payee was innocent.”

Corrective Payments

A participant or beneficiary “may make corrective payments in a lump sum, in installments, or, with regard to overpayments involving periodic payments, through reductions in future payments,” according to the guidance.

“If a plan sponsor chooses not to seek recoupment from a participant or beneficiary (or is unsuccessful in obtaining full recoupment), the plan sponsor or another person generally must make the corrective payments to the extent the full overpayment amount is not repaid to the plan,” the guidance states.

Further, if an overpayment is not corrected by plan amendment, “the plan sponsor generally must notify the participant or beneficiary in writing that the overpayment is not eligible for the favorable tax treatment accorded to distributions from an eligible retirement plan and is not eligible for tax-free rollover.”

Tax-Favored Status

For instance, one question addresses the circumstances under which an individual who rolls over an inadvertent benefit overpayment to an eligible retirement plan can retain the overpayment in tax-favored status.

The IRS explains that “under section 402(c)(12)(A), the portion of a rolled-over inadvertent benefit overpayment for which recoupment is not sought is treated as an eligible rollover distribution if the payment would have been an eligible rollover distribution but for being an overpayment.”

Accordingly, the IRS continues, “… an individual who receives an inadvertent benefit overpayment and rolls over that overpayment pursuant to a direct or 60-day rollover retains the tax-favored status of the overpayment for the portion of the overpayment for which recoupment is not sought.”

Further, “if an inadvertent benefit payment is rolled over from an originating plan to a second plan and recoupment of all or a portion of the inadvertent benefit payment is sought, then the amount that is sought and transferred back to the originating plan is treated both as an eligible rollover distribution from the originating plan and as an eligible rollover distribution transferred back to the originating plan,” the IRS explained.