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SECURE Act 2.0: Recouping Overpayments – New Clarity and New Obstacles

Getting money back from retirement plan participants who have been inadvertently overpaid has never been an easy process. The windfall has often been spent before the plan discovers the error and asks for its money back. Repayment may be a real hardship, collection efforts are often futile or scarcely worth the cost and effort, and until now legal guidance has been murky.

SECURE Act 2.0 attempts to dispel the fog by setting forth rules governing recoupment. It frees plan fiduciaries from the fear that failure to recoup will lead automatically to fiduciary liability (a fear that was, however, largely misplaced) and imposes limits on recoupment that are intended to minimize the burden on innocent participants.

For the benefit of plans and plan fiduciaries, the Act makes modest changes to current law:

First, fiduciaries acting within the scope of their discretion, that is, not arbitrarily and capriciously, are not liable for decisions to refrain from seeking recoupment of inadvertent overpayments. Under prior law, it was generally taken for granted that fiduciaries had no obligation to seek recoupment when the cost was likely to exceed the recovery, because that wasn’t a course of action that a “prudent man” would follow. Under the new law, a fiduciary doesn’t have to demonstrate that its decision was prudent; instead a plaintiff must demonstrate that it was arbitrary and capricious, a far more fiduciary-friendly standard. That protection is contingent, however, on the restoration or anticipated restoration of the plan’s loss..

In a defined contribution plan, where an overpayment to one participant means that plan assets no longer equal the sum of participants’ account balances, the deficiency may be rectified through allocations from the plan’s forfeiture account, additional employer contributions or recoveries from the parties responsible for the overpayment (such as a recordkeeper that misstated a participant’s account balance or an actuary that miscalculated benefits).

In a defined benefit plan, restoration is an automatic consequence of the minimum funding standards, and nothing further need be done, unless the pertinent fiduciary determines (again applying an “arbitrary and capricious” standard) “that failure to recover all or part of the overpayment faster than required under such funding rules would materially affect the plan’s ability to pay benefits due to other participants and beneficiaries”.

Second, overpayments may, if desired, be corrected by amending the plan to increase the benefits of participants who were overpaid without adversely affecting the plan’s qualified status. The IRS already allows amendments of this kind quite liberally via the Employee Plans Compliance Resolution System, but the new law puts that remedy on a statutory footing and perhaps overrides some of the restrictions imposed by EPCRS, such limitations on the availability of self-correction. As is already the rule under EPCRS, a corrective amendment cannot authorize violations the IRC §415 benefit limitations or the §401(a)(17) limitation of the compensation that a plan may take into account in calculating benefits. Other potential issues, such as compliance with the IRC §401(a)(4) prohibition against discrimination in favor of highly compensated employees, are left to future IRS guidance.

Corrective amendments may be useful alternative to recoupment where pension benefits were modestly miscalculated or where a distribution included benefits that were not yet vested.

Third, if a plan “has established prudent procedures to prevent and minimize overpayment of benefits and the relevant plan fiduciaries have followed such procedures, an inadvertent benefit overpayment will not give rise to a breach of fiduciary duty”. That reassuring statement is simply a corollary of the well-established ERISA principle that the “prudence” demanded of fiduciaries is procedural prudence, not necessarily the correct outcome.

On the participant side, SECURE Act 2.0 offers a variety of ameliorations of the obligation to repay, so long as the recipient of the overpayment (i) was not responsible for the overpayment (that is, didn’t mislead or defraud the plan) and (ii) did not know that the payment was “materially in excess of the correct amount”.

The Act goes on to say that someone isn’t considered to have known that a payment was incorrect if he “raised that question with an authorized plan representative and was told the payment or payments were not in excess of the correct amount’’.

Recoupment from non-culpable participants is subject to the following restrictions. Note that none of these prevents a plan from adjusting future benefit payments to the proper level. The only effect is on its ability to recover overpayments made in the past.

  • The plan may not recoup overpayments if the first overpayment occurred more than three years before the participant was first notified of the error. That should not be read as merely a prohibition against recouping more than three years of overpayments. If the first excess payment was made three years and one month ago, all past overpayments are immune to recoupment.

  • The plan may recover only the face amount of the overpayments without interest, collection costs or any other additions.

  • If overpayments are recouped by reducing payments due in the future (a common procedure for pension plans), the reduction must cease when the full amount of the overpayment has been recovered, no more than ten percent of the overpayment may be recovered each year, the reduction in benefit payments from the level that would be paid without recoupment may not exceed ten percent, and recoupment may not be “sought from any beneficiary of the participant”, which implies that it must cease at the participant’s death.

  • The plan may not threaten the participant with litigation “unless the responsible plan fiduciary makes a determination that there is a reasonable likelihood of success to recover an amount greater than the cost of recovery”.

  • The plan may not utilize a collection agency until and unless it obtains a final judgment or settlement holding the participant liable to the plan.

(N.B.: While the summary refers to “participants”, the same rules apply if an overpayment is made to a beneficiary and isn’t merely the result of overpaying the participant. For instance, if a pensioner receives the correct benefit amount during his lifetime but the benefit to his survivor annuitant is miscalculated, the plan may recoup from the beneficiary. On the other hand, if the participant is overpaid, the plan may not recoup by reducing the survivor annuity.)

The new rules became effective on the date of enactment, December 29, 2022, but don’t affect repayment programs that were already in effect on that date. If a plan is, for instance, recouping past pension overpayments by a reduction in future benefit payments greater than the Act permits or is charging interest on the amount subject to recoupment, it doesn’t have to modify the recoupment schedule.

Reference: ERISA §206(h) and IRC §414(aa), as added by Pub. Law No. 117-328, Div. T, §301

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