SECURE 2.0 and retirement plan overpayments: A plan sponsor’s guide to the new legislation

The SECURE 2.0 Act of 2022, signed into law on December 29, 2022, aims to improve and protect retirement savings in the United States. Among its 92 provisions is one that significantly changes the correction of overpayments to participants in employer-sponsored retirement plans—some of which may net cost savings while others may prove costly for plan sponsors.

The changes include additional protections for employees who receive overpayments, and time limits for plan sponsors and administrators seeking to recoup the funds. As a result, funds that could be collected under the old law might not be recoverable under the new one. However, in certain circumstances, a plan sponsor barred from recoupment may not need to replace these “lost” funds.

On the whole, plan sponsors are likely to recover less money on average under the new framework. As a result, plan sponsors must be extra vigilant to avoid overpayments in the first place.

Why retirement plan overpayments occur

Overpayments are not as uncommon as one would think. The pension world is inordinately complex, and a large plan may distribute funds to thousands of participants over the course of its lifetime, following myriad rules for the payouts.

Lack of information about material changes can lead to overpayments. When someone dies, the plan must be informed, and often there is a delay in that notification. Typically, a plan sponsor learns of a deceased participant via third-party data services that scour county and state databases. Meanwhile, plans also need to make adjustments for life events such as divorces or child support settlements, which have their own complications, such as when a court orders that plan payments be split between the participant and an alternate payee. Consequently, miscalculations may not only occur but also could persist for years.

When these mistakes go unnoticed, the overpayments can become quite large. Overpayments happen so often, in fact, that the Internal Revenue Service (IRS) Employee Plans Compliance Resolution System (EPCRS) addresses how plans can recoup the monies, and that process was also revised as part of the new law. In addition, plan documents typically specify rules for recovering overpayments, which should be reviewed in light of the new law.

How SECURE 2.0 changes retirement plan overpayments

SECURE 2.0 makes several changes to the existing guidance.¹ Some of the revisions may provide cost savings to plan sponsors as they now have enhanced discretion to not seek recoupment in certain circumstances. SECURE 2.0 makes it clear that any decision to seek recoupment of inadvertent overpayments would need to be made in a fiduciary capacity. For example, the fiduciary is allowed to consider any hardship that would be imposed on the participant by seeking to recover all or some part of the overpayment. In certain cases, the new rules may create a win-win situation for both the plan participants and sponsor (e.g., where the amount overpaid is not excessive, thereby creating a situation where the administrative and/or legal costs of seeking recoupment would potentially exceed the amount recovered).

However, the new law also features the following restrictions that provide protection to participants but may prove costly to the plan sponsor that decides to pursue collection of overpayments:

• Plan sponsors cannot seek recovery if the plan notifies a participant more than three years after its first overpayment, unless the recipient committed fraud or misrepresentation.
• Plans cannot apply interest on the amount of the overpayment, nor can they tack on expenses for collections.
• Plans are also restricted on litigation. They can’t threaten to sue a participant unless the fiduciary ascertains that there’s a reasonable likelihood of success to recover an amount greater than the cost of recovery.
• Plans may not seek recoupment of a participant’s overpayment against a spouse or other beneficiary.
• A participant or beneficiary must be entitled to contest the recoupment pursuant to the plan’s claims procedures.

Furthermore, when plan sponsors seek to recover overpayments by reducing future benefit payments, SECURE 2.0 provides the following restrictions:

• Reductions must cease after the plan has recovered the full dollar amount of the overpayment.
• The amount recovered in a calendar year cannot exceed 10% of the total sum of the overpayment.
• Future benefit payments are not reduced below 90% of the periodic amount otherwise payable under the terms of the plan.
• The plan must comply with any applicable limitations imposed by Internal Revenue Code (IRC) section 401(a)(17), the annual compensation limit, and IRC section 415, the limit on annual additions or annual benefit payments. (Note: the IRS may provide guidance on how these limits are enforced in connection with recouping benefit payments, as well as satisfying other qualified plan requirements).

Further relief is provided to participants and beneficiaries with the new law’s inclusion of rollover protection provisions intended to prevent them from incurring potential adverse tax consequences from the rollover of inadvertent overpayments:

• Overpayment amounts not sought by the plan sponsor, i.e., inadvertent overpayments rolled over into an eligible retirement plan, will be treated as an eligible rollover distribution
• Overpayments sought in recoupment may be returned to the original plan and treated as eligible rollovers

Exception for culpable individuals

The previously described limitations on a plan sponsor’s right to recover overpayments do not apply to protect a participant or beneficiary who is “culpable” with respect to an overpayment. For this purpose, the law specifies that such individuals are “culpable” if they bear responsibility for the overpayment (e.g., through misrepresentations or omissions that led to the overpayment) or knew the benefit payment or payments were materially more than the correct amount.

However, the law also provides an exception that frees these individuals from such culpability, provided all the following criteria are met:

• They merely believed the benefit payment or payments were or might be more than the correct amount
• They raised that question with an authorized plan representative
• They were told the payment or payments were not more than the correct amount

If overpayments are not recovered, does the plan have to be made whole?

There is some good news for plan sponsors, depending on their plan’s circumstances. SECURE 2.0 modifies the so-called “make-whole” contributions, giving more flexibility on whether the plan must be repaid. Under the previous framework, the plan had to be made whole from the responsible party, whether that be from the participant or beneficiary, the plan sponsor, or another plan fiduciary. SECURE 2.0 doesn’t require the make-whole contribution, unless:

• A defined benefit (DB) plan’s ability to pay out other participants is materially affected
• A defined contribution (DC) plan is not able to restore funds to the plan without making a contribution (e.g., restoration of a forfeited account from a participant who terminated prior to vesting)
• The overpayment was due to a fiduciary breach, or impermissible forfeitures were made.

SECURE 2.0 overpayment relief: Effective date

While the above-described changes became effective as of December 29, 2022 (i.e., the date SECURE 2.0 was signed into law), the relief is retroactive for certain actions taken prior to December 29, 2022. Accordingly, plans, fiduciaries, employers, and plan sponsors may 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
• 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.

There’s plenty of gray area here and need for additional guidance. Ultimately, there’s still a fiduciary duty of the plan to conduct its due diligence to make the trust whole. In the case of a benefit overpayment that occurred prior to December 29, 2022, any installment payments by the participant or beneficiary to the plan or any reduction in periodic benefit payments to the participant or beneficiary, which were made in recoupment of such overpayment and which commenced prior to such date, may continue after such date. Nothing in the new law is intended to relieve a fiduciary from responsibility for an overpayment that resulted from a breach of its fiduciary duties.

What can plan sponsors do to reduce or eliminate overpayments?

It is best practice for plans to have and follow written policy to prevent or minimize benefit overpayments, and to have procedures in place to handle overpayments when they occur.

Based on our experience, we can offer best practices for plan sponsors to reduce or eliminate overpayments:

• Regularly run death audit reports
• Send letters to retirees (or a subset of retirees) to confirm they are still alive, suspending benefits if they do not respond
• Review periodic reports isolating individuals with special optional benefit forms (such as the Social Security level income option), temporary benefits (such as disability payments prior to retirement and bridge benefits), or qualified domestic relation orders (QDROs) in which not all parties are in pay status.

Next steps

Now is a good time to review your plan document and administrative procedures to determine whether any changes are necessary in light of this new framework for collecting overpayments. If any errors are identified during this review, plan sponsors may be able to “self-correct” those errors under EPCRS to remain tax-compliant. Plan sponsors should also work with their third-party administrators (TPAs) who handle overpayments to see if some adjustment is needed to service agreements to account for the shift in processes and procedures.

¹ Section 301 of SECURE 2.0 Act of 2022. See https://www.congress.gov/117/bills/hr2617/BILLS-117hr2617enr.pdf, pages 878-879.