Keep a Close Eye on Compliance in Retirement Plan Overpayments

Sometimes, retirement plans pay participants more than they are owed. The start of the new year is one time when plan administrators commonly deal with these “overpayments,” following year-end audits.

New rules under the SECURE 2.0 Act that allow more leniency in recovering overpayments from retirement plans were welcomed by plans and their advisers when the law was enacted in December 2022. Implementing these new rules involves grappling with some complexity and nuances, and different plans will adopt different policies. Plan administrators have discretion regarding some aspects of the new rules. They should work closely with counsel to ensure overpayment policies meet all applicable legal requirements while being flexible enough to handle each employee’s situation.

Overpayments can occur in both defined benefit plans—such as pension plans—and defined contribution plans—such as 401(k) plans—for many reasons. These include misapplying plan rules, such as the employer match or the pension formula, and failing to receive updated employee information for benefit payments.

For example, if a retired employee dies and their survivors fail to notify the plan, the plan may continue sending pension checks to the retiree for as long as the mistake remains undiscovered. Sometimes these errors persist for months, or even years.

The following are some key issues that can be easy to overlook when determining how to handle overpayments.

Written notification. The first step that plan administrators may want to take upon discovering an overpayment is to notify the recipient in writing.

This isn’t strictly necessary under SECURE 2.0’s modified rules. But under some interpretations of SECURE 2.0, it might preserve the plan’s right to recover future overpayments, even if the plan chooses not to recover the current overpayment.

Disqualified persons. Even plan fiduciaries who have formally adopted or revised overpayment procedures in the wake of SECURE 2.0 often haven’t incorporated the more recent IRS guidance issued in Notice 2024-77.

Several key overpayment rules appear only in that notice. For example, under the notice, the IRS wouldn’t consider an overpayment inadvertent under SECURE 2.0 if it was made to a disqualified person under tax code Section 4975(e)(2). The term “disqualified person” in that section includes plan fiduciaries and certain highly compensated employees. As such, SECURE 2.0 may not exempt plans from recovering overpayments to such persons.

Culpability analysis. Under SECURE 2.0, if the recipient is culpable for an overpayment, plan administrators have greater flexibility to recover it. When a recipient isn’t culpable, SECURE 2.0 added limits to a plan’s right to recover the overpayment.

For this reason, a lot of the analysis hinges on whether the recipient of an overpayment is culpable. While it’s tempting to focus on whether the recipient engaged in any wrongdoing, the statute’s language states that a recipient is culpable if the recipient “bears responsibility for the overpayment (such as through misrepresentations or omissions that led to the overpayment.)” This language doesn’t require that the recipient acted wrongly or bore exclusive responsibility for the overpayment, only that the recipient provided or omitted information that led to the overpayment.

For example, if a surviving spouse fails to notify the plan about a participant’s death, the surviving spouse could be treated as culpable under the statute for any overpayments that ensue. Adopting this approach would increase a plan’s ability to recover the overpayment, if it chooses to do so.

Cliff effects. Some plan administrators may consider adopting a dollar threshold for recovering overpayments. This makes it easier for plan administrators to forgo small amounts that are deemed to be not worth the recovery effort. For example, the policy might state that overpayments totaling $1,000 or less won’t be recovered if SECURE 2.0 permits non-recovery.

But this type of policy has a potential “cliff effect.” For example, suppose a participant received an overpayment of $2,500 and non-recovery is permitted under SECURE 2.0. Will plan administrators who adopt a $1,000 recovery threshold require the participant to return the full amount (we call this a “cliff rule”) or will the participant be allowed keep the first $1,000 (and return only $1,500)?

The cliff rule is easier to administer, but it also may be less equitable. A participant who was overpaid $999 would be allowed to keep the full amount, whereas a participant who was overpaid $1,001 would be required to return everything. For this reason, plan administrators should carefully assess the pros and cons of adopting a cliff rule. Balancing ease of administration and participant fairness is always difficult.

Alternative relief. Although SECURE 2.0 (and IRS guidance there under) significantly modified the rules for handling plan overpayments, they don’t comprise the full set of relevant overpayment rules.

For example, the IRS’s Employee Plans Compliance Resolution System—which was separately modified under SECURE 2.0—still continues to apply. One key relief rule under EPCRS exempts plans from recovering de minimis overpayments of $250 or less. This rule would apply even to overpayments that SECURE 2.0 doesn’t otherwise permit plan administrators to forego.

To ensure maximal compliance and flexibility, plan administrators should be sure to incorporate all relevant overpayment rules into their internal overpayment policies, whether those rules arise under SECURE 2.0 or otherwise.

We encourage plan administrators to consider the specifics of these updated rules sooner rather than later, so that a plan can update its rules for addressing overpayments—and take the time to consider all the nuances—before a time-sensitive situation arises. Adopting a thoughtful policy also helps prevent inconsistent treatment between overpaid participants.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jodi Epstein is partner at Ivins, Phillips & Barker with more than 25 years of experience with all aspects of employee benefits.

Alex Maged is an associate at Ivins, Phillips & Barker and supports clients on a wide range of employee benefits issues.

Write for Us: Author Guidelines