Correcting retirement plan overpayments under SECURE 2.0 

   
   
July 28, 2023
Retirement plans have long grappled with how to correct inadvertent benefit overpayments, struggling to balance fiduciary obligations to the plan with issues of fairness to recipients, equity among participants and administrative practicality. The SECURE 2.0 Act of 2022 (Div. T of Pub. L. No. 117-328) gives fiduciaries and plan sponsors a new road map for addressing inadvertent overpayments, including the flexibility to choose not to recoup. However, the act imposes a slate of new protections for ERISA plan participants and beneficiaries when plan officials seek recovery. These new rules took effect immediately, though the IRS and Department of Labor (DOL) haven’t yet issued any implementation guidance.

Scope of the provision

Plan officials are sometimes reluctant to recoup benefit overpayments, especially if the overpayment is large or occurred a long time ago. But guidance on IRS’s Employee Plans Compliance Resolution System (EPCRS) has suggested that sponsors must attempt recovery of all but the smallest overpayments to maintain the plan’s tax-favored status, although EPCRS updates over the years seemed to give some leeway in this regard. (EPCRS doesn’t address whether fiduciaries must seek recoupment of overpayments to satisfy their ERISA duties.)

SECURE 2.0 explicitly grants fiduciaries broad — though not unlimited — discretion to decide not to recoup an "inadvertent” benefit overpayment while still fulfilling their ERISA responsibilities and maintaining the plan’s tax-favored status. (However, the act doesn’t provide any guidelines for determining whether an overpayment is inadvertent.) Fiduciaries generally can decide not to pursue recovery of inadvertent overpayments from:

  • Participants and beneficiaries
  • Any employer sponsoring or contributing to a defined benefit (DB) plan — unless failure to recoup would materially affect the DB plan’s ability to pay benefits to other participants — or a defined contribution (DC) plan
  • Any fiduciary responsible for the overpayment, unless the overpayment resulted from a fiduciary breach (no breach occurs if the fiduciary followed prudent procedures to prevent and minimize overpayments)

The statute doesn’t require fiduciaries to abandon all attempts at recoupment, however. Fiduciaries may seek the return of overpayments, subject to several new safeguards for participants and beneficiaries. (Certain of these protections don’t apply when the participant is culpable.) The act also clarifies that fiduciaries won’t violate ERISA or the Internal Revenue Code (IRC) if they reduce future benefit payments to the correct amount or seek to recover some or all of the overpaid amount.

Protections for participants

Fiduciaries who seek recoupment from participants and beneficiaries must comply with limits on recovery amounts, recoupment methods and the timing of recoveries. The statute distinguishes between overpayments arising from a nondecreasing annuity (typically paid from DB plans) and other forms of payment (usually a lump sum, but also other accelerated forms of payment, such as installments or a Social Security level-income option).

No interest on overpayment

The fiduciary can’t charge participants any interest on overpayments, including for the period after repayments begin. This differs from overpayment corrections under EPCRS, which generally permits and sometimes requires interest, except in certain specified situations (see Coordination with EPCRS below). The act also prohibits charging participants any additional amounts, such as collection costs or other fees.

Limits on overpayments arising from nondecreasing annuities

When the overpayment arises from a nondecreasing annuity, DB sponsors often seek to recoup the excess amounts by reducing future benefit payments. This approach may be preferable to direct repayment because the participant doesn’t have to pay any money out of pocket, and the reduction can be implemented automatically without the participant’s explicit consent. However, SECURE 2.0 limits how large the reduction can be and how long it can last:

  • The amount recovered each year can’t exceed 10% of the full dollar amount of the repayment.
  • Future benefit payments can’t be reduced below 90% of the amount otherwise payable (i.e., the ongoing benefit can’t be reduced by more than 10%).
  • The reduction must stop as soon as the full dollar amount of the overpayment has been recovered.

The first two conditions effectively mean that the annual reduction in the benefit can’t be more than 10% of the lesser of (i) the overpayment or (ii) the annual benefit amount. Therefore, full recovery will take at least 10 years.

Example. A participant received monthly benefit payments of $2,000 starting Jan. 1, 2023. In May 2025, a plan audit reveals that the original calculation didn’t properly reflect the participant’s lengthy break in service, so the correct monthly benefit should be $1,400. The plan administrator is able to adjust the benefit to the correct level for the July 1, 2025, payment.

The participant received an extra $600 for 30 months, or a total overpayment of $18,000. If the fiduciary decides to recoup the overpayment by reducing future benefits, the relevant limitations are as follows:

•The maximum amount recovered each year can’t exceed 10% of $18,000, or $1,800 ($150 per month).

•The participant’s monthly benefit can’t be reduced below 90% of $1,400, or $1,260 (a reduction of $140 per month).

In this case, the reduction cannot exceed 10% of the benefit, or $140 per month. Using $140, the overpayment would be recovered over 128.57 months ($18,000/$140 = 128.57), which is 10 years and 8-1/2+ months. For simplicity, the administrator chooses to recover the overpayment over 11 years (132 payments) through a monthly reduction of $136.36 ($18,000/132 = $136.36).

The participant will therefore receive payments of $1,263.64 ($1,400 - $136.36) for 11 years, after which the payment will revert to $1,400. Note that repayments needn’t commence at the same time the benefit is initially reduced from $2,000 to $1,400. Because no interest is charged on the overpayments, the calculation of the reduction won’t depend on when the correction begins. As soon as the benefit amount is corrected, the overpayment amount is final.

Alternatively, the act allows a fiduciary to recover an overpayment through installment payments. Although the statutory language provides for “one or more” installments, the act appears to limit the maximum amount recouped through such payments in any given calendar year to 10% of the ongoing benefit payable in that year. Given this restriction, the installment approach will likely be attractive only if the overpayment is small relative to the ongoing benefit. (The act can be read to also limit total yearly installments to 10% of the total overpayment, which might make this approach far less appealing. However, the statutory language isn’t entirely clear, and agency guidance confirming that this limit doesn’t apply to installment payments made during a year would be helpful.)

Example. A participant retires July 1, 2023, and elects a 50% joint and survivor benefit of $1,900, payable by direct deposit. When the bank processes the paperwork, a life annuity amount of $2,000 is mistakenly entered into the system. The retiree doesn’t pay close attention to his account, so the error isn’t caught until the following February when data is reviewed as part of the annual actuarial valuation. The bank begins paying the correct amount April 1, 2024. In total, the participant received $900 extra ($2,000 - $1,900 = $100 for nine months from July to March).

If the overpayment were recouped as a reduction in future payments, the ongoing monthly payment couldn’t be reduced below 90% of $1,900, so the maximum reduction would be 10% of $1,900, or $190 per month. This means that the maximum amount the plan can recover in any year through installment payments is $2,280 ($190 x 12). Because the total overpayment is only $900, the full amount can be recouped in a single lump sum or, if preferable, over multiple installments. (This example assumes the additional limitation that restricts annual reductions in future payments to 10% of the total overpayment doesn’t apply to installment payments.)

Limits on overpayments arising from accelerated forms of payment

When an overpayment arises in connection with a lump sum or other accelerated form of payment, recovery can be significantly more difficult. In many cases, the participant will have no ongoing payments to reduce, and the amounts involved may be much larger. In this scenario, the statute provides no direction as to the maximum amount that can be recovered in any particular time period. The act requires DOL to develop requirements that fiduciaries must satisfy when making such recoupments. Until DOL issues this guidance, fiduciaries should consult legal counsel.

Three-year notification window

A fiduciary can’t seek recoupment if the first overpayment occurred more than three years before the participant or beneficiary received written notice about the error, except in cases of fraud or misrepresentation. If the error is still ongoing (for example, a DB plan participant’s monthly benefit is too high), the fiduciary would need to correct future benefit payments but couldn’t make additional reductions for prior overpayments. This deadline may put pressure on plan officials to notify participants as soon as an error is identified, so as to avoid losing the possibility of pursuing recoupment. The act provides no guidance for determining what kinds of participant misconduct rise to the level of fraud or misrepresentation, or how this exception to the notification window relates to the general exception for participant culpability (discussed below).

No recoupment from overpaid participant’s beneficiary

A fiduciary can’t try to recover overpayments made to a participant from any of the participant’s beneficiaries. Guidance is needed to clarify whether this prohibition extends to efforts to recover from the participant’s estate if the estate isn’t a beneficiary.

Example. A participant in a DB plan elects a 50% joint and survivor annuity of $2,000 per month. Due to a data entry error, the participant receives $2,200 per month for three years, or a total overpayment of $7,200. The most the plan can recoup in a single year by reducing the participant’s benefit payment is $720 (10% of $7,200), or $60 per month. The participant’s benefit is reduced to $1,940 per month (the corrected benefit of $2,000 minus $60), but the participant dies six years later, having repaid only $4,320. The spouse will receive the full 50% survivor benefit of $1,000 per month, even though the plan hasn’t recouped $2,880 of the overpayment.

This restriction doesn’t appear to prevent fiduciaries from seeking recovery of overpayments made to a beneficiary after the participant’s death. However, the statute is silent as to whether any restrictions on the recoupment of overpayments made to a beneficiary apply after the beneficiary’s death.

Guardrails on litigation and collection actions

A fiduciary can’t threaten litigation without first determining that the plan has “a reasonable likelihood of success” of recouping more money than the cost of recovery. Recoupment efforts generally can’t be made through a collection agency or similar third party, unless the participant or beneficiary fails to comply with the terms of a settlement agreement or a final federal or state court judgment.

Ability to contest recoupment

Participants may contest all or part of a recoupment through the plan’s claims procedures. The statute specifies that if the participant rolled over all or part of the overpayment to an eligible retirement plan (such as another qualified plan, 403(b) plan or IRA), the paying plan must notify the receiving plan about the dispute. The act doesn’t specify whether this notice requirement applies to indirect rollovers — in such cases, the plan likely wouldn’t know about the rollover or have contact information for the receiving plan. Once notified, the receiving plan must keep the money until the dispute is resolved. If the disputed amount is determined to be an overpayment, the receiving plan may return the funds to the paying plan as an eligible rollover distribution in lieu of distributing the amounts to the participant.

May consider hardship to participants

When determining how much of the overpayment to recoup from a participant or beneficiary, the fiduciary may — but doesn’t have to — consider any hardship the recoupment would impose. The statute doesn’t suggest other factors the fiduciary can or should consider when deciding whether to recoup from a participant or any other source.

Participant culpability

Most of the statutory protections listed above don’t apply to a participant or beneficiary who is culpable for the overpayment. For this purpose, individuals are culpable if they are responsible for the overpayment (for example, through misrepresentation or omission) or knew the benefit was materially overstated. Participants aren’t deemed culpable if they raised concerns about overstated benefit payments with an authorized plan representative and were told the payments were correct.

Even culpable participants must have the ability to contest the recoupment under the plan’s claims procedures. Those who rolled overpayments into an eligible retirement plan receive rollover protection while disputing the recoupment effort, and fiduciaries may take hardship into account when determining whether and how much to recoup from a culpable participant. But the other protections listed above don’t apply.

Protections for plans

While protecting participants from having to return money erroneously paid to them through no fault of their own, the law also protects plans from disqualification due to decisions to recoup (or not recoup) inadvertent overpayments. Plans also are shielded from certain consequences arising from rollovers of overpaid amounts.

Qualification requirements

A plan won’t fail to meet the IRC Section 401(a) qualification or Section 403(b) requirements just because the plan doesn’t recoup some or all of an inadvertent benefit overpayment from any source. Nor will a 401(a) or 403(b) failure occur simply because the sponsor amends the plan to increase past or decrease future payments to affected individuals to account for prior overpayments. However, plans may reduce future benefit payments to the correct amount and seek recovery from the person responsible for the overpayment. Such plans will continue to be considered retirement plans for determining whether individuals have reduced deductible limits for IRA contributions under Section 219(g)(5).

Regardless of whether the plan recovers some or all of an overpayment, the sponsor must continue to meet the minimum funding standards of IRC Sections 412 and 430, and must prevent or restore any impermissible forfeitures under the vesting standards of Section 411. In addition, plans will still have to recoup overpayments from participants to the extent benefits exceeded the applicable compensation and benefit limits under IRC Sections 401(a)(17) and 415.

Treasury may issue regulations or other guidance specifying how these recoupment rules coordinate with any other qualification requirements.

Rollovers

If the responsible fiduciary chooses not to recoup some or all of an inadvertent benefit overpayment that was rolled over to another eligible retirement plan, the receiving plan can continue to treat the excess payment as an eligible rollover and needn’t take any corrective action. Any portion of a rolled-over overpayment returned by the receiving plan to the original plan can be treated as an eligible rollover distribution by both plans.

Effective date and applicability

The new overpayment correction rules took effect Dec. 29, 2022, on SECURE 2.0’s enactment. Sponsors may rely on a reasonable good-faith interpretation of previously existing guidance for any decision made before Dec. 29, 2022, to recoup or not recoup some or all of an inadvertent overpayment. Installment payments or reductions in future payments that began before SECURE 2.0’s enactment may continue, even if they don’t align with the new provisions — for instance, an installment payment that reflects interest on overpaid amounts. Fiduciaries who had identified overpayments but hadn’t initiated corrections at the time of SECURE 2.0’s enactment should consult legal counsel.

Coordination with EPCRS

A separate section of SECURE 2.0 significantly expands EPCRS’s self-correction provisions for inadvertent errors. Notice 2023-43 provides interim guidance on how retirement plan sponsors may proceed with self-correction before IRS updates Rev. Proc. 2021-30 — the current version of EPCRS. However, the notice deliberately doesn’t address the new overpayment provisions (see The ABCs of IRS FAQs on EPCRS under SECURE 2.0 (June 6, 2023) for more information on the EPCRS expansion).

The 2021 update of EPCRS added two new DB overpayment correction options. One of these corrections, the “contribution credit correction method,” includes several participant protections when a plan seeks recoupment, including a 10% cap on any reduction in future payments and a prohibition against charging interest before repayments begin. However, these and other EPCRS overpayment correction options permit — and in some cases, require — repayment terms that conflict with SECURE 2.0’s new overpayment provision. For instance, most EPCRS overpayment corrections require adjusting overpayments with appropriate interest (for DB plans) or earnings (for DC plans) and generally don’t permit treating an excess amount as an eligible rollover.

Nothing in SECURE 2.0 or Notice 2023-43 suggests that existing EPCRS overpayment corrections are no longer available. However, to the extent an EPCRS correction method would conflict with SECURE 2.0’s overpayment provision, the two approaches will need to be reconciled. Until IRS updates EPCRS to account for SECURE 2.0’s overpayment provision, fiduciaries in this situation should consult legal counsel.

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About the author(s)
Margaret Berger
Matthew Calloway
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