Where in the World Are Your Missing Participants? Commonly asked questions about Handling Missing Participants Accounts.

Transcription

1 Where in the World Are Your Missing Participants? Commonly asked questions about Handling Missing Participants Accounts

2 A Guide for Employers Table of Contents Introduction... 3 What is a missing participant?... 3 When may the plan treat a participant as missing?... 3 Under what circumstances may a plan distribute an account balance without a participant s (or spouse s) consent?... 3 If a participant terminates employment and has a vested account balance not over $5,000, what distribution options does the participant have?... 4 If a terminated participant s vested account balance does not exceed $5,000 and the participant is missing, may the plan still distribute the account balance from the plan?... 4 Must a plan provide for an involuntary cash-out of vested account balances not exceeding $5,000?... 4 May the plan forfeit (i.e., keep) a missing participant s vested account balance that is over $1,000 but not over $5,000?... 5 What are the distribution alternatives if a participant s vested account balance is $1,000 or less? What if the participant is missing?... 5 May the plan forfeit (i.e., keep) the account of a missing participant that is $1,000 or less?... 5 If the plan provides for distribution to a participant with a vested account balance of $1,000 or less, the plan makes the distribution (subject to a mandatory 20% withholding), and the check returns to the plan undelivered, what options are available to the plan?... 6 May the plan simply remit to the IRS as withholding 100% of a missing participant s account balance as a means of eliminating the account?... 6 If a participant s vested account balance exceeds $5,000 and the participant terminates employment, may the plan distribute the participant s vested account balance without the participant s consent?

3 If a participant does not consent to a distribution following termination of employment and the vested account balance exceeds $5,000, how long must the plan keep the account before distributing?... 6 If the plan is a J&S plan, and a participant s vested account balance exceeds $5,000, may the plan distribute the participant s vested account balance in a lump sum at NRA without the participant s or spouse s consent?... 7 How should the plan deal with the account of a participant who has reached NRA, if the participant is missing?... 7 If the participant s vested account balance exceeds $5,000 at the time of termination of employment, but subsequently drops to $5,000 or below, may the plan distribute at that point?... 7 If the plan discovers a participant with a vested account balance exceeding $5,000 is missing prior to the participant s attainment of NRA, may the plan distribute at that time?... 7 What requirements must a defined contribution plan satisfy to be able to distribute a participant s account balance without consent upon termination of the plan?... 8 If a defined contribution plan terminates, what steps must the plan administrator take before treating a participant as a missing participant?... 8 If none of the steps described in the previous question results in locating the participant, what else, if anything, must a terminating plan do before treating the participant as a missing participant?... 8 Once a terminating defined contribution plan determines a participant is missing, how should the plan deal with the participant s account balance?... 9 How does a terminating defined benefit plan deal with benefits payable to a missing participant?... 9 How does a plan fiduciary s choice of distribution options with respect to a missing participant impact the tax consequences to the participant?... 9 In summary, how should the plan decide between forfeiting, distributing, and rolling over the account balance of a missing participant?... 9

4 Introduction Handling the accounts of missing participants in a qualified plan complicates plan administration. Even if the plan provides for an immediate distribution upon termination of employment, the plan may be unable to locate a participant. Alternatively, the plan may lose track of a participant who declined to receive a distribution upon termination of employment, and may be unable to locate a participant when, years later, the plan must distribute the participant s account balance. Statutory rules govern when a plan may distribute a participant s account without the consent of the participant or the participant s spouse. This pamphlet explains the rules that permit a defined contribution plan, such as a 401(k) plan or a profit sharing plan, to make distributions to missing participants. This pamphlet also addresses some of the rules that apply to missing participants in a defined benefit plan. What is a missing participant? For purposes of this pamphlet, a missing participant is any participant who is either unresponsive to communications from the plan administrator or whose whereabouts are unknown. The plan may have a last known address for the participant but may not know if the participant currently receives communications at that address. Some plan administrators use the term lost rather than missing. For purposes of this pamphlet, a missing participant is the same as a lost participant. When may the plan treat a participant as missing? The plan administrator should follow the terms of the plan to the extent the plan prescribes specific steps to take before declaring the participant to be missing. In addition, the Department of Labor ( DOL ) has provided specific steps (discussed below) a terminating plan must take before treating a participant as missing. Although not required in every situation, these steps provide a checklist of what the DOL considers reasonable, and a plan administrator would be well advised to follow the steps in dealing with missing participants in an ongoing plan. Under what circumstances may a plan distribute an account balance without a participant s (or spouse s) consent? A plan may distribute an account balance to a missing participant under any of three circumstances: 1. The participant has terminated employment and the participant s vested account balance does not exceed $5,000. 3

5 2. The participant has terminated employment, and has attained the plan s normal retirement age, or age 62 if later (the later event is referred to in this pamphlet as NRA ). 3. The plan is a defined contribution plan (e.g., a 401(k) plan or a profit sharing plan), that is being terminated (subject to some exceptions). If a participant terminates employment and has a vested account balance not over $5,000, what distribution options does the participant have? The plan (either defined contribution or defined benefit) may provide for an involuntary cash-out for a terminating participant with a vested interest not exceeding $5,000. The participant may elect either to receive the distribution (subject to a mandatory 20% withholding requirement) or to roll over the distribution to another eligible retirement plan (including an individual retirement account or annuity ( IRA )). However, under a recent law change (the automatic rollover rules ), if the plan has an involuntary cash-out provision, the participant s vested interest is over $1,000 but not over $5,000, and the participant does not elect whether to receive or to roll over the distribution (whether the participant is missing or simply is unresponsive), the plan must roll over the distribution to an IRA. If a terminated participant s vested account balance does not exceed $5,000 and the participant is missing, may the plan still distribute the account balance from the plan? Yes. If the plan (either defined contribution or defined benefit) provides for an involuntary cash-out of participants with a vested account balance not exceeding $5,000, the plan may distribute the account balance of a missing participant from the plan. If the vested account balance is over $1,000 and not over $5,000, the plan must roll over the distribution to an IRA. Must a plan provide for an involuntary cash-out of vested account balances not exceeding $5,000? No. However, this is an extremely common plan provision. If an employer wishes to amend its plan to eliminate the involuntary cash-out provision in order to avoid having to make any automatic rollovers for terminating participants, it may do so. However, the effect of eliminating the involuntary cash-out provision is that the plan will not be able to distribute the participant s account, without the participant s consent, until the participant attains NRA (or under the death distribution rules). Since a participant s attainment of NRA may be years in the future, 4

6 the plan may incur substantial administrative expenses to hold the account until distribution, and the delayed distribution increases the possibility that the participant will become a missing participant, requiring the plan to incur the expense associated with administering the missing participant s account at a later date. Failure to provide for an involuntary cash-out also requires the plan to delay forfeiture of the participant s nonvested account balance for at least five years after termination of employment. May the plan forfeit (i.e., keep) a missing participant s vested account balance that is over $1,000 but not over $5,000? No. Given the requirement of an automatic rollover for a participant who does not elect either to receive or to roll over the distribution, the plan should roll over, and should not forfeit, the account balance. What are the distribution alternatives if a participant s vested account balance is $1,000 or less? What if the participant is missing? If the vested account balance is $1,000 or less, the plan (either defined contribution or defined benefit) may provide, in the absence of a participant s election, either for a default rollover or for a default distribution. Consult your pension advisor or your plan document to determine your plan s method of dealing with a $1,000 or less account. If the participant is missing, the plan may use an automatic rollover to an IRA to eliminate the account balance while assuring compliance with the fiduciary requirements associated with the distribution. May the plan forfeit (i.e., keep) the account of a missing participant that is $1,000 or less? Since the automatic rollover rules do not apply to a vested account balance of $1,000 or less, the rules do not prohibit a forfeiture. However, a plan fiduciary deciding how to dispose of a participant s account must act in the best interest of the participant. Since the automatic rollover rules permit a plan to use an automatic rollover for an account balance of $1,000 or less, and since the rollover preserves the retirement account for the participant, a question may arise whether declaring a forfeiture is consistent with proper exercise of fiduciary responsibility. The account should probably not be forfeited unless the plan specifically requires a forfeiture. Note that invoking a forfeiture will require that the plan restore the account if the participant ever makes a claim for the account, potentially requiring the employer to restore the forfeiture from its own assets at a later date. 5

7 If the plan provides for distribution to a participant with a vested account balance of $1,000 or less, the plan makes the distribution (subject to a mandatory 20% withholding), and the check returns to the plan undelivered, what options are available to the plan? If the plan administrator determines the participant is missing, the plan may treat the remaining account balance like any other missing participant s account. The plan s most conservative choice is to roll over the remaining account balance to a rollover IRA. If the plan requires forfeiture of the participant s account balance, the plan administrator may follow the plan s forfeiture provisions. May the plan simply remit to the IRS as withholding 100% of a missing participant s account balance as a means of eliminating the account? No. While the law requires mandatory 20% withholding on an eligible rollover distribution that the participant does not roll over (subject to a limited exception for distributions for the entire year totaling less than $200), there is no authority for 100% withholding. Furthermore, the Internal Revenue Code generally provides a three-year period from the due date of a particular year s tax return during which to request a refund. If the IRS fails to match the 100% withholding with the participant s income tax return (if any) for the taxable year, the participant eventually will be unable to request a refund of the 100% withholding. At that time, the participant may seek recovery from the plan for the amount improperly withheld. If a participant s vested account balance exceeds $5,000 and the participant terminates employment, may the plan distribute the participant s vested account balance without the participant s consent? Generally, if the participant s vested account balance is over $5,000, the participant must consent to receive a distribution, unless the participant has attained NRA. If a participant does not consent to a distribution following termination of employment and the vested account balance exceeds $5,000, how long must the plan keep the account before distributing? The plan must maintain the account balance until the participant attains NRA. When the participant attains NRA, the plan may be drafted provided that the account balance be distributed without the participant s consent. A plan that is not subject to the joint and survivor annuity requirements (not a J&S plan ) may provide for a lump sum distribution at that time. 6

8 If the plan is a J&S plan, and a participant s vested account balance exceeds $5,000, may the plan distribute the participant s vested account balance in a lump sum at NRA without the participant s or spouse s consent? No. When a terminated participant attains the plan s NRA, a joint and survivor plan must distribute a participant s vested account balance in the form of a joint and survivor annuity, unless the participant, with spousal consent if married, waives the joint and survivor form of benefit. How should the plan deal with the account of a participant who has reached NRA, if the participant is missing? Although there is not clear guidance regarding this problem, the plan should be able to roll over the account balance to an IRA. If the plan administrator follows the automatic rollover rules, the plan administrator should have protection under DOL guidance against a claim of breach of fiduciary liability. Prior to declaring the participant to be a missing participant, the plan administrator should follow all of the steps described below with respect to the distribution from a terminating defined contribution plan. The account balance should only be forfeited if the plan specifically requires a forfeiture and all reasonable efforts to locate the participant have failed. If the participant s vested account balance exceeds $5,000 at the time of termination of employment, but subsequently drops to $5,000 or below, may the plan distribute at that point? Yes. Subject to the same notice requirements that apply to any eligible rollover distribution (i.e., notice to the participant regarding the participant s right to elect whether to receive the distribution or to roll over the distribution), the plan may distribute at a later date, even if the vested account balance at the time of termination of employment exceeded $5,000. If the plan discovers a participant with a vested account balance exceeding $5,000 is missing prior to the participant s attainment of NRA, may the plan distribute at that time? No. If the participant s vested account balance exceeds $5,000, the plan may not distribute (or forfeit) the participant s account balance before the participant s attainment of NRA unless the participant consents. The fact that the participant is missing is not by itself a reason to distribute to the participant. 7

9 What requirements must a defined contribution plan satisfy to be able to distribute a participant s account balance without consent upon termination of the plan? If a defined contribution plan terminates, the plan does not offer an annuity distribution option, and the employer does not maintain another defined contribution plan (other than an ESOP), the plan may distribute upon plan termination without the participant s consent. Note that all J&S plans, including all defined benefit plans, must provide an annuity option, and therefore are not eligible to use this distribution option upon termination. You should consult your plan advisor or the plan document if you are not sure whether your plan is a J&S plan. Note also that forcing a distribution to a participant upon plan termination does not necessarily result in adverse tax consequences to the participant, since almost all distributions on plan termination are eligible for rollover. If a defined contribution plan terminates, what steps must the plan administrator take before treating a participant as a missing participant? The DOL requires a plan fiduciary to take at least four steps prior to treating the participant as missing. The steps: 1. Certified mail. Send notice of the distribution to the participant by certified mail. 2. Other plan records. Check records of other plans of the employer, such as a group health plan, to ascertain the participant s location. 3. Designated beneficiary. Attempt to identify and contact the participant s designated beneficiary to ascertain the participant s location. 4. Letter-forwarding service. Use either the IRS or the Social Security Administration letter-forwarding service. Contact your plan consultant regarding the details of either of these programs. If none of the steps described in the previous question results in locating the participant, what else, if anything, must a terminating plan do before treating the participant as a missing participant? The plan administrator may use other search methods, such as Internet search tools, commercial locator services and credit reporting agencies to locate the participant. Whether the plan administrator should use other search methods and which to use depends upon the circumstances, including the size of the account balance in relation to the cost of the service. 8

10 Once a terminating defined contribution plan determines a participant is missing, how should the plan deal with the participant s account balance? The DOL s preferred distribution option is to roll over the distribution to an IRA, since that option most likely will preserve the participant s retirement plan assets. If the plan cannot locate an IRA provider willing to accept a rollover distribution, the plan administrator may consider establishing an interest-bearing federallyinsured account in the missing participant s name, or transferring the participant s account balance to the state unclaimed property fund. The plan should not forfeit the participant s account balance upon plan termination, since there will be no plan assets from which to restore the forfeiture if the participant later makes a claim. How does a terminating defined benefit plan deal with benefits payable to a missing participant? A special provision of the law requires almost all terminating defined benefit plans to transfer the benefits of missing participants to the Pension Benefit Guaranty Corporation. How does a plan fiduciary s choice of distribution options with respect to a missing participant impact the tax consequences to the participant? If the plan does not transfer the distribution to a taxdeferred vehicle such as an IRA, the distribution is taxable to the participant. In addition, a distribution to a participant who has not attained at least age 59½ is subject to an additional 10% tax for a premature distribution, unless an exception applies. Therefore, placing the participant s account balance in an interestbearing checking account in the participant s name (other than an IRA) or escheating the account to a state unclaimed property fund results in a taxable distribution. Any interest earned on funds not rolled over to an IRA also is subject to income taxation on a continuing basis. In summary, how should the plan decide between forfeiting, distributing, and rolling over the account balance of a missing participant? The decision depends on the amount of the distribution, the reason for the distribution, the type of plan and the plan terms. If the participant terminates employment with a vested account balance of $5,000 or less and the plan (defined contribution or defined benefit) provides for an involuntary cash-out distribution of accounts 9

11 not exceeding $5,000, the plan must roll over a vested account balance exceeding $1,000 but not exceeding $5,000, even if the participant is missing. If the vested account balance of a terminating participant is $1,000 or less, the plan terms will determine whether the plan will roll over, or forfeit the missing participant s account. If the missing participant s vested account balance exceeds $5,000, and the plan is a J&S plan (which includes all defined benefit plans and some defined contribution plans), the plan may not distribute or roll over the participant s entire vested account balance without the consent of the participant, and if married, the consent of the participant s spouse. The J&S plan may forfeit a missing participant s account only as provided in the plan, and only after the participant attains the plan s NRA. If the missing participant s account exceeds $5,000, and the plan is not a J&S plan, the plan may roll over the account when the participant attains NRA. The non-j&s plan may forfeit a missing participant s account only as provided in the plan after the participant attains the plan s NRA. Forfeiture is permissible only if the plan provides for restoration of the forfeited account balance at any time the participant later makes a claim. If the non-j&s plan terminates, the plan may roll over the missing participant s account balance, or may consider a distribution to an interest-bearing account or escheat to the state. 10

12 The information provided in this pamphlet is based upon complex requirements of the Internal Revenue Code and Treasury Regulations. It is provided with the understanding that the preparer is not engaged in rendering legal, accounting, or other professional services. Although care has been taken to present the material accurately, the preparer disclaims any implied or actual warranties as to the accuracy of any material herein and any liability with respect thereto.