The IRS Is in its Overpayment Guidance Era

The U.S. Internal Revenue Service (IRS) recently issued long-awaited guidance on how to handle “inadvertent benefit overpayments” from qualified retirement plans (IRS Notice 2024-77 effective October 15, 2024) (Notice). The Notice provides clarity around certain issues left unresolved in the original provisions added by the SECURE 2.0 Act of 2022 (SECURE 2.0), including

1. whether a plan sponsor is required to recoup an inadvertent benefit overpayment
2. whether such overpayments may be treated as eligible rollover distributions
3. inconsistencies between the correction procedures outlined in the Employee Plans Compliance Resolution System (EPCRS) and the applicable SECURE 2.0 provisions

Background

EPCRS describes correction methods for overpayments from certain employer-sponsored retirement plans. Prior to the Notice, if a plan sponsor unintentionally made payments out of a benefit plan, EPCRS required specific corrective actions — the plan sponsor had to either recoup those payments from the participant or beneficiary or make corrective payments to restore such amounts to the plan. In addition, the overpayments were not eligible for rollover treatment, and plan sponsors had to provide notification to recipients that any such rollovers had to be reversed. SECURE 2.0 amended the Employee Retirement Income Security Act (ERISA) and the U.S. Internal Revenue Code (Code) to provide that plans will not lose their tax-qualified status or violate ERISA if they fail to recover certain inadvertent benefit overpayments.

Inadvertent Benefit Overpayments

The Notice defines “inadvertent benefit overpayment” as an eligible inadvertent failure that occurs due to a payment made from a plan that exceeds the amount payable under the terms of the plan or a limitation provided in the Code or regulations. However, it does not include (i) a payment made to a “disqualified person” or owner-employee or (ii) a payment that is made pursuant to an EPCRS correction method for a different qualification failure. 

Corrective Payments and Recoupment

According to the Notice, corrective payments are generally no longer required with respect to an inadvertent benefit overpayment. However, other failures could occur as a result of the inadvertent benefit overpayment that would still require corrective payments, including failures to observe any of the funding-based benefit restrictions for a defined benefit plan or failures to observe Code contribution limits for defined contribution plans. In addition, a plan sponsor may not amend a plan to increase past benefit payments in a manner that results in a violation of such Code limits for a prior year. 

Note that although the recoupment of the overpayment is no longer required, it is still permitted and remains an optional correction method under EPCRS guidance. 

Rollovers of an Inadvertent Benefit Overpayment

Pursuant to the Notice, any portion of a rolled-over inadvertent benefit overpayment for which the plan does not seek recoupment is now treated as an eligible rollover (i.e., receives favorable rollover tax treatment) so long as the payment would have qualified as an eligible rollover had it not been an inadvertent benefit overpayment. 

If recoupment is sought after an inadvertent benefit overpayment was rolled over into another qualified plan, the amount that is transferred back into the originating plan is treated as an eligible rollover distribution and both plans are treated as allowing the transfer, regardless of the terms of either plan. Any amount for which recoupment is sought but is not returned is not treated as an eligible rollover distribution, and the plan sponsor must notify the participant or beneficiary that such amount is not eligible for favorable tax treatment.

Knowledge Management lawyer Katie Dean contributed to this Sidley Update.