There comes a time when employees leave the company for greener pastures or retirement. If they’ve been loyal and dedicated, they’ll likely get cake and a card—maybe even a luncheon. Then they will continue along their life’s journey. Unfortunately, many companies don’t understand the full impact former employees can have on their retirement plan.
For example, most plan sponsors adopt procedures for locating former employees or beneficiaries who have not cashed out of the 401(k) or other defined contribution plan. What happens, however, when a plan sponsor is not able to track down a missing participant? While plans can cash out some participants automatically, such as those with small account balances, participants with higher balances might choose to stay in the plan. And when they do, administrators run the risk of losing track of them.
Missing Participants and Unclaimed Property
If ex-employees leave contributed and vested funds of less than $5,000 in their former employer's 401(k) or other tax-qualified defined contribution plan, these funds are subject to automatic rollover into an individual retirement account (IRA) in the participant's name (see “Satisfying the 401(k) Rollover Safe Harbor”).
Participants with account balances above $5,000 who are no longer active employees become a continuing cost, offset somewhat if larger overall asset holdings in the plan result in lower administrative fees. Plan sponsors are obligated to maintain communication with ex-employee participants but run the risk of becoming disconnected, making it difficult to meet fiduciary obligations. In addition, it puts the organization at risk for problems with unclaimed property reporting.
Many abandoned property laws include dormancy periods for unclaimed amounts in tax-deferred retirement plans. Generally, the state of last known address of the missing participant is the one that benefits in an unclaimed property situation. And because unclaimed property laws vary by state, some might attempt to claim employee benefit payments or distributions under the “general escheat” provision in that state’s abandoned property laws.
The problem gets worse when a former employee dies. Death is a distributable event in a defined contribution plan. For example, if someone dies, their beneficiary should receive their distribution. But, if the plan sponsor doesn’t know that the former employee has died, it can’t initiate the distribution and might find itself in the awkward position of having to explain why the former participants’ account balances declined between the time their beneficiaries were due a distribution and the time they received it.
The ERISA Factor
This is where the Employee Retirement Income Security Act (ERISA) comes in. ERISA requires that plans provide the following:
• Information about the plan, including important information about plan features and funding.
• Minimum standards for participation, vesting, accrual of benefits and funding of plans.
• Length of time a person may be required to work before the person becomes eligible to participate in a plan, to accumulate benefits and to have a non-forfeitable (i.e. “vested”) right to receive those benefits.
While the Internal Revenue Code generally prohibits the forfeiture of vested retirement benefits, a special provision allows the forfeiture of retirement benefits for missing participants, provided the benefit is reinstated if the participant is ever located. Furthermore, to protect ERISA plan administrators from having to comply with various state unclaimed property laws, ERISA supersedes state laws that relate to any employee benefit plan it governs.
Though ERISA is meant to help plan administrators and sponsors—and has alleviated many potential headaches around unclaimed property—plan sponsors and administrators still face the challenge of maintaining accurate data and keeping track of former employees.
Take for instance the 2008 U.S. Supreme Court ruling in LaRue v. DeWolff, Boberg & Associates. Former employee LaRue instructed the 401(k) plan to make changes in his retirement plan investments. Those instructions were not followed. When the value of his account declined as a result of the plan’s inaction, LaRue filed suit. Under ERISA, participants generally have been allowed only to sue as part of a class, rather than individually, but the Supreme Court allowed LaRue’s action. So what does this mean for plan sponsors? It clears the way for individual participants in other plans to sue when they believe that fiduciaries are acting improperly.
To help plan sponsors and administrators terminate defined contribution plans smoothly, the U.S. Department of Labor (DOL) provides guidelines. For example, all plan assets must be distributed as soon as possible once it is determined that the plan must terminate. If a plan fiduciary is unable to reach plan participants, search methods are required. In this instance, any ERISA fiduciary must follow the following search methods:
• Reach out to participants via certified mail.
• Review related plan records.
• Make inquiries to designated plan beneficiaries.
• Employ the IRS letter-forwarding service.
After all search methods have been exhausted, the DOL acknowledges that plan fiduciaries must still distribute benefits in order to terminate plans. Employers with terminating plans should then consider rollovers into IRAs or transfers into federally insured bank accounts.
As with ex-employee accounts of under $5,000, the preferred distribution treatment for accounts of any size left in a terminating plan is rollover into IRAs. This technique is preferred because it preserves the benefit value by transferring the entire account balance and defers the consequences of income tax to the participant.
Although endorsed by the DOL, IRA rollovers still raise some issues. Choosing an IRA plan and a plan custodian/trustee is a fiduciary decision. As a result, it might be difficult to locate IRA providers that will accept missing participant rollovers.
Plan fiduciaries can consider establishing an interest-bearing, federally insured bank account in the missing participant’s name. However, this option isn’t without issue either. Rolling a benefit plan into a bank account has tax consequences for the participant and presents great potential for unclaimed property consequences. If the participant never learns about the rollover or the account and three to five years (depending on the state’s dormancy period) of inactivity have passed, the state of last known address for the participant can claim the funds if that state has inactivity provisions.
Don't Lose Touch
While there is no one-size-fits-all approach for plan sponsors and administrators, one thing is certain: Employee data needs to be analyzed on an annual basis and scrubbed for errors and outdated information. Create an internal system for assessing data quality to help cut down on the number of missing participants remaining in your retirement plans. In addition, when employees are leaving the company, provide them with instructions on how to roll over their benefit funds into an IRA or a new employer’s plan.
By staying on top of data quality and the whereabouts of former employees, you can control costs better, stay in compliance and fulfill obligations to keep participants abreast of pertinent plan information.
Mark Sweatman is president of Keane Retirement Services, a division of The Keane Organization, a provider of compliance and risk management solutions to Fortune 1000 corporations.
Related External Articles:
Finding Lost Participants, Benefit Resources Blog, February 2013
Finding Missing Participants Without the IRS Letter-Forwarding Program, Buck Consultants, September 2012
Related SHRM Articles:
Missing Retirement Plan Participants: Please Take Your Money!, SHRM Online Benefits, December 2010
Retirement Plan Sponsors Should Keep Track of Former Employees, SHRM Online Benefits, February 2009
Satisfying the 401(k) Rollover Safe Harbor, SHRM Online Benefits, October 2004
SHRM Online Benefits Discipline