Former employer deposited money in my 401K by accident

Question

Former employer put about $3K in my 401K after I had left the company for 1 year. A year later they discovered it and are asking for the money back. Do I legally owe this to them?

Answer 1

Option 1: Contact the company and inform them that, due to their mistake, you will need to consult with a professional (accountant, tax attorney, whatever) in order to resolve it. This professional will work out how much of this money could be returned to them without you suffering any financial loss.
You need to tell them that this professional's fee (and potentially some compensation for your own time spent) will be deducted from whatever amount of money you might be found liable to return to them.
Then ask them if they still wish for you to continue with this course of action or if they are going to write off their error.
Get an answer in writing from someone in authority (not Betty the receptionist or Bill the security guard).

Option 2: Ignore them and wait for them to decide whether or not they're going to waste more time & money on an attorney - if they do, see option 1.

Either way, as others have pointed out, you need to know how this was reported to the IRS in order for you to be able to get your own house in order.

Answer 2

I'm not a lawyer, and I'll gladly yield to any lawyer who can discuss the specifics of this situation. But in general, if someone gives you money accidentally, yes, you are legally required to give it back. If it was you who made the mistake, you would surely expect the other person to return the money. If you wrote a check for something that cost $10 and you accidentally wrote $100, I can't imagine that you would now be saying, "Oh, it was my mistake, so they should be allowed to keep the money."

In the case of an investment fund, figuring out how much you owe them could be complex. If they deposited, whatever, say $5,000 to your account, and the value of the fund fell so that now it is only worth $4,000, it certainly would not be legitimate for them to demand you come up with another $1,000 to repay them. On the other hand if the value of the fund has increased, they could reasonably say you owe them the original amount plus the increase. (Years ago I saw a story in the news that someone was expecting an income tax refund of a few hundred dollars and for some reason the IRS made a mistake and sent him a check for millions. He got the clever idea that he would deposit the check to his bank account, promptly notify the IRS of the mistake so they couldn't claim he was trying to keep the money, and then when they went through whatever burocracy and told him to return the money, he'd return the principle but keep all the interest that the many-millions had earned during the delay. Nice try, but the IRS demanded he give them the interest earned, too.)

As others have noted, 401K's have tax implications and that would need to be straightened out. If this money put you over contribution limits, you could be facing tax penalties. If it was reported as an employee contribution, you could have unintentionally have subtracted it from your income and paid less taxes than you owe. Etc.

I would expect that the employer and the fund manager could work all this out and make appropriate reports to the tax man. Fund managers do this all the time and should know how. And if you correct the numbers from the fund manager on your taxes for money you moved around to correct this mistake, the IRS is likely to look at that closely. Maybe the fund manager needs your permission to give the money back, but they shouldn't expect you to do the legwork. If they did, then you would likely need a tax account or lawyer to advise you on how to do it right, and at that point you would be justified in demanding that your former employer reimburse you for your expenses in correcting their mistake.

In most if not all states, there is a statute of limitations on bringing lawsuits for debts or reporting unpaid debts to the credit bureaus. It depends on the state and the type of debt, but it's generally 5 to 10 years, I think. If you want to be dishonest about this, if you can drag things out for 10 years you may be off the hook legally.

Answer 3

I am not a lawyer.

You need to call/contact the plan administrator, explain the situation and see if they can direct you to someone useful, and see if you need to direct your ex-employer to them.

Employers can't just take back vested contributions without a legal basis. It's also made tricky by the fact that 1) the plan has undoubtedly has written procedures about how/when contributions must be returned, and 2) the contribution was made over a year ago, and so you aren't in the same plan year as the excess contribution. They need to follow the provisions of the plan.

If the employer wants to recoup that money, they need to carefully proceed forward with your plan holder, the IRS and probably their own legal team. Otherwise, they will just make things messier. This looks to me like an attempt to strong-arm you to avoid this process, but you would have to either pay them out of pocket or take the early withdrawal penalties like that.

I think you should minimize your contact with the ex-employer, and do not acknowledge owing them anything personally. They should be able to initiate something like a corrective distribution from the plan without much interface with you.

Your goal isn't to hang on to the money at all costs, but to determine a legal and proper path forward, if applicable. If the proof is valid and the correct processes are followed, you won't get to keep that money, but it also shouldn't be a taxable event.

Answer 4

Yes you owe them, if not legally then morally.

The question will be how much. You will want to calculate what the contribution is now worth. See what shares were bought with the extra money, and how those shares performed, including any dividends or capital gains they triggered.

You also want to know if this was reported to the IRS, and was it reported as company match, or as an employee contribution. A nightmare scenario is that they reported it as an employee contribution, and that put you over the yearly maximum. They need to adress how the IRS documents will be corrected.