RYAN KADEVARI and NICHOLAS J. WHITE, March 30, 2023
On December 29, 2022, President Biden signed the SECURE 2.0 Act of 2022 (“SECURE 2.0”) into law as part of the Consolidated Appropriations Act of 2023. SECURE 2.0, which builds upon the original Setting Every Community Up for Retirement Enhancement Act, contains numerous developments that affect retirement plans. Significant among these developments are changes to the methods available to plan sponsors for correcting plan overpayments. These new rules provide plan fiduciaries with increased discretion and greater latitude for correcting overpayments, and they emphasize protecting the financial security of participants and beneficiaries.
Plan Overpayments and Historical Correction Methods for Overpayments Under EPCRS
Among retirement plans, a relatively common error occurs when a plan mistakenly pays a participant or beneficiary more money than they are owed, which results in a plan qualification failure. Historically, correction procedures for retirement plans, including defined benefit and defined contribution plans, are contained in the Employee Plans Compliance Resolution System (EPCRS), which is promulgated by the Internal Revenue Service (IRS) through various Revenue Procedures. (See IRS Revenue Procedure 2021-30 for the most recent consolidation statement of EPCRS.) EPCRS contains several approved methodologies for correcting overpayments, including attempts to recover overpayments directly or by offsetting future benefit payments to recoup the overpayment. In certain circumstances, EPCRS permits plan sponsors to correct overpayment failures without seeking recoupment of an overpayment from the participant or beneficiary. However, the plan sponsor (or another person) has been generally responsible for contributing any overpayment amounts that are not repaid to the plan. EPCRS also requires that a plan notify the overpayment recipient that the overpayments are not eligible for favorable tax treatment (i.e., not eligible for tax-free rollover). As discussed in detail below, SECURE 2.0 directly amended the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (the “Code”) and codified new rules governing plan fiduciaries’ attempts to recover plan overpayments, including liability protection for fiduciaries who choose not to seek repayment of inadvertent overpayments.
SECURE 2.0 Changes to Overpayment Recovery
Effective as of December 29, 2022, new ERISA section 206(h) provides liability protection for plan fiduciaries who choose not to seek recovery of an inadvertent overpayment to a participant or beneficiary. The protection extends to the decision not to seek restoration from the plan sponsor.
In the case of a defined benefit plan, the relief does not permit a failure to recoup inadvertent overpayments if that would adversely affect the ability of the plan to pay benefits due to other participants and beneficiaries. Where a defined contribution plan fiduciary does not seek restoration from the plan sponsor, the fiduciary must be able to restore funds without having to make a contribution to the plan (e.g., a restoration from a forfeiture account).
The relief also applies when the fiduciary chooses not to seek repayment from another fiduciary whose breach was responsible for the overpayment — but only if the plan has established “prudent procedures” to prevent and minimize the overpayment of benefits, and the relevant plan fiduciaries have followed such procedures.
SECURE 2.0 adds parallel rules under new section 414(aa) of the Internal Revenue Code (the “Code”) to maintain a plan’s tax-qualified status in the event a fiduciary decides not to seek recoupment of an overpayment or takes alternative corrective actions. Specifically, Code section 414(aa) permits, in lieu of a reduction of future benefit payments to recoup an overpayment, the adoption of a retroactive plan amendment that entitles the participant to the higher payments made (i.e., the overpayment amount). Section 6.06 of EPCRS currently permits an increase in benefits to eliminate an overpayment; SECURE 2.0 now codifies that option. In making such a retroactive amendment, a plan sponsor must still observe any limitations imposed by Code section 401(a)(17) (limiting the amount of annual compensation that can be used to calculate a participant’s retirement benefit) and Code section 415 (limiting maximum annual contributions to a plan).
Plan fiduciaries may still qualify for the relief from liability even if they seek recovery of the overpayment
A plan or plan fiduciary will not fail to qualify for relief merely because, after discovering an overpayment, the plan or plan fiduciary takes action to recoup the overpayment, either by reducing future benefit payments to the correct amount or by seeking recovery from the person(s) responsible for the overpayment.
If a plan fiduciary does not seek recovery of the overpayment, the recipient is permitted to continue to treat the overpayment as eligible for a tax-free rollover (if it otherwise qualifies as an eligible rollover dist ribution). Alternatively, if the plan fiduciary decides to recover the overpayment, the portion of the overpayment shall be permitted to be returned to the plan and treated as an eligible rollover distribution transferred to the plan.
A more complicated scenario arises if an overpayment is made to a participant or beneficiary and is subsequently rolled over to another plan. In such an instance, if a plan fiduciary seeks recoupment but the participant or beneficiary who received the overpayment disputes the recoupment, then the dispute is subject to the plan’s claims procedures. The plan fiduciary that made the overpayment is tasked with notifying the plan that received the overpayment as a rollover of the dispute. Upon notice, the recipient plan is then required to retain the overpayment pending resolution of the claim.
Limitations on SECURE 2.0’s Fiduciary Relief
Under the new law, there are rules in place limiting a plan fiduciary’s ability to recover overpayments from participants and beneficiaries. These rules are intended to take into account the burden and potential hardship faced by retirees and their beneficiaries who receive overpayments — typically through no fault of their own. In such instances, the impact of a plan’s recovery can be financially significant and jeopardize a retiree’s financial security. Accordingly, if a plan fiduciary does decide to recover overpayments from a participant or beneficiary, they must comply with the following new limitation on the recovery:
- no recovery if the first overpayment occurred more than three years before written notification of the overpayment error to the participant or beneficiary, except in the case of fraud or misrepresentation by the participant or beneficiary;
- no attempt to recoup an overpayment to a participant may be made against a beneficiary, including a spouse or former spouse of the participant; and
- no recovery of interest or collection costs or fees on the overpayment.
If the plan seeks to recoup overpayments of an annuity by reducing the participant’s or beneficiary’s future benefit payments:
- the amount recouped each calendar year may not exceed 10% of the total overpayment amount;
- future benefit payments may not be reduced below 90% of the periodic amount otherwise payable under the plan; and
- the reduction must stop as soon as the full amount of the overpayment is recovered.
If recovery is made via one or more installment payments, the sum of those payments in any calendar year may not exceed the amount the plan could recover by reducing future benefit payments. Recoupment of amounts other than annuity payments will be subject to requirements that are to be developed by the Department of Labor.
SECURE 2.0 also makes clear that recoupment of overpayments to a participant cannot be sought from any beneficiary of the participant, including a spouse, surviving spouse, former spouse, or other beneficiary. However, this rule raises a question (which will likely be resolved through future guidance) regarding recoupment of payments made erroneously to a participant after their death and whether these may be recouped through various means, including stop payment orders or reversals of direct deposits. SECURE 2.0’s prohibition on recoupment from spouses or other beneficiaries appears to be aimed at preventing recoupment from a spouse or beneficiary receiving benefits as part of a Qualified Joint and Survivor Annuity (QJSA). However, it is currently unclear whether the prohibition also applies in situations involving overpayments made after a participant’s death.
In addition, a plan’s efforts to recover overpayments may not include threats of litigation unless the responsible fiduciary determines the plan is reasonably likely to recover more than the cost of recovery. The use of a collection agency or similar third party to recover an overpayment is now prohibited under ERISA, unless there is a court judgment or settlement agreement authorizing such recovery and the participant or beneficiary ignores or rejects the plan’s recovery efforts short of litigation.
Furthermore, in line with SECURE 2.0’s emphasis on taking into account participant and beneficiary financial security, a plan fiduciary may take into account the level of financial hardship that recoupment would likely impose on the participant or beneficiary in determining whether to pursue recoupment (or determining the amount of the recoupment).
Lastly, participants and beneficiaries from whom an overpayment is sought must be permitted to appeal a plan’s recovery pursuant to the plan’s claims and appeals procedures. Notably, SECURE 2.0 clarifies that these limitations don’t apply to recovery of overpayments from third parties (e.g., the third-party administrators or recordkeepers).
Although SECURE 2.0 creates additional protections from overpayment recovery, the new law does not provide blanket protection to all participants and beneficiaries. The foregoing limitations on a plan’s right to recover overpayments — other than the right to file a claim or appeal — do not apply to protect a participant or beneficiary who is “culpable” with respect to an overpayment. A participant or beneficiary is “culpable” if the individual bears responsibility for the overpayment (such as through misrepresentations or omissions that led to the overpayment) or knew the benefit payment or payments were materially in excess of the correct amount.
However, an individual is not culpable with respect to an overpayment if:
- they merely believed the benefit payment or payments were or might be in excess of the correct amount,
- they raised that question with an authorized plan representative, and
- they were told the payment or payments were not in excess of the correct amount.
Effective Date of SECURE 2.0 Overpayment Relief
The amendments made by these provisions of SECURE 2.0 are effective immediately (i.e., December 29, 2022, the date SECURE 2.0 was signed into law). However, the relief is retroactive for certain actions taken prior to December 29, 2022. Specifically, plans, fiduciaries, employers, and plan sponsors are entitled to rely on:
- a reasonable good faith interpretation of then-existing administrative guidance for inadvertent benefit overpayment recoupments and recoveries that commenced before December 29, 2022; and
- determinations made before enactment by the responsible plan fiduciary, in the exercise of its fiduciary discretion, not to seek recoupment or recovery of all or part of an inadvertent benefit overpayment.
In addition, any recovery of overpayments that was in place prior to the enactment of SECURE 2.0 may continue after the effective date. Please contact one of our attorneys if you have any questions regarding correction of benefit overpayments.