Sooner or later, every retirement plan will have to deal with participants who have terminated employment but still have balances in the plan. In most circumstances, the plan document provides guidance on how to proceed; however, there are a number of factors that can make the determination a little more complex than what it seems at first blush.
Why do we Care?
Before exploring the options for handling former participant balances, it is helpful to understand several aspects of plan maintenance that may steer employers in one direction or another.
Count the Cost
Many plan service providers set their fees in whole or in part based on plan size. This may include total assets, the number of participants, average account balance or some combination of these factors. Understanding how fee schedules are structured is one factor in determining the most appropriate policy for dealing with former plan participants. For example, if fees decrease as plan assets increase, it might make sense to design the plan to minimize outflows to terminated participants. On the other hand, if fees increase as average account balances decrease and many former participants have below-average balances, taking steps to expedite distributions may be the more appropriate course of action.
Stand and be Counted
The number of participants is used to determine another critical threshold for retirement plans–the plan audit threshold. Generally, plans with more than 100 participants on the first day of any plan year are required to engage an independent qualified public accountant to audit the plan’s financial statements and attach the audit report to Form 5500. Former participants with remaining balances are counted for purposes of the 100-participant threshold.
Since it is not uncommon for the cost of a plan audit to reach five figures, plan sponsors often seek to delay being subject to the requirement as long as possible. One way to do this is, to the extent possible, to design the plan so that former participants can/must have their balances distributed to them as soon as possible following termination of employment.
Tell the Participants
Anyone who works with retirement plans on a semi-regular basis is quite aware of the seemingly endless number of disclosures that must be provided to participants, including the Summary Plan Description, Summary Annual Report and many others. A number of these disclosures include information describing the rights of anyone with a balance in the plan, so they must be provided to former employees as well.
While the IRS and Department of Labor (DOL) both allow certain documents to be provided via electronic means such as e-mail, the requirements for doing so can be daunting with respect to former employees who no longer access a company e-mail account as part of their jobs. Plan options that allow for immediate distributions can minimize the burden of providing many of these disclosures to former employees.
Tell the IRS
Participant disclosures are not the only concern. Plans that include former employees with remaining balances are required to file a form with the IRS each year. Prior to 2009, this information was required to be attached to Form 5500; however, after a temporary suspension of this reporting requirement, it is now satisfied by filing Form 8955-SSA directly with the IRS each year.
The form lists the name, social security number and vested account balance for terminated employees. The IRS shares this information with the Social Security Administration so that it can notify recipients of social security benefits that they may be entitled to additional benefits from a former employer’s retirement plan. As a result, plans must not only report participants when they terminate, they must also monitor prior years’ forms and “un-report” terminees once they receive distributions.
What are the Options?
Plan sponsors have a fair degree of flexibility in designing their plans to deal with former participants with balances; however, once the design is determined, sponsors must consistently follow the provisions they put in place.Small Balances
IRS and DOL rules allow plans to force distributions to former participants with vested account balances of less than $5,000 after providing them with at least 30 days advance notice of their right to request a cash distribution or a rollover to an IRA or a new employer’s plan. Due to concern that automatically cashing out former employees could cause them to prematurely spend amounts they had set aside for retirement, the rules require employers to establish rollover IRAs on behalf of former participants with balances between $1,000 and $5,000 who do not respond to the advance notice. Those with less than $1,000 can be cashed out with the appropriate taxes withheld. These rules leave sponsors with several plan design options.- Force out all vested balances below $5,000 with those from $1,000 to $5,000 going to IRAs and those below $1,000 being paid in cash;
- Force out all vested balances below $5,000 with all of them going to IRAs;
- Force out all balances below $1,000 with all of them being paid in cash; or
- Eliminate forced distributions altogether.
Larger Balances
Terminated employees with vested balances exceeding $5,000 generally cannot be forced out of a plan; however, plan sponsors can provide them with the applicable notices and forms to communicate distribution options. There is one important exception to this general rule. Any portion of a participant’s account that was rolled into the plan from an IRA or an unrelated employer’s plan can be disregarded for purposes of the $5,000 forced distribution limit. Consider this example. Joe Participant has terminated employment and has a total vested account balance of $14,000 as follows:| Elective Deferrals | $3,000 |
|---|---|
| Employer Match | 1,500 |
| Rollover | 9,500 |
| Total | $14,000 |
Fees
IRS and DOL guidance allows plans to charge certain fees to participant accounts. This includes not only ongoing plan management expenses but also distribution fees. However, the plan document must include language authorizing the charges and the method of allocating the expenses must be disclosed to participants, usually in the Summary Plan Description. For example, the plan may provide that general management expenses are allocated proportionately based on account balance while distribution fees are charged directly to the accounts of the participants requesting the distributions.Residual Distributions
From time-to-time, a former employee takes a full distribution of his or her account before all contributions or investment gains are allocated. This may occur, for instance, in a safe harbor 401(k) plan for which the employer allocates a 3% nonelective contribution at the end of the plan year. Since these contributions cannot be subject to a last day of employment rule, any participant eligible at any point during the year is entitled to the contribution even if he or she terminated employment earlier in the year. So, what happens to the residual account balance generated by the contribution? The answer depends somewhat on timing. As described above, terminated participants must be provided with a distribution notice at least 30 days in advance of a distribution. The notice is considered “stale” after 180 days. Therefore, if the residual contribution is credited to the participant’s account fewer than 180 days after the date the notice was provided, the plan can issue a distribution of the residual using the same method as the initial payment, e.g. cash distribution, rollover to IRA, etc. If it has been more than 180 days, the account is subject to the distribution rules in the same manner as if there had been no previous distribution paid. In many such situations, the residual balance will be below the forced distribution threshold and can be processed as such.What about Plan Terminations?
When an employer elects to terminate its plan, all participants are entitled to take distributions regardless of their employment status. Generally speaking, the distributions are processed according to the rules outlined above. But, what happens when participants with more than $5,000 do not make a distribution election? What happens if notices to former employees are returned due to invalid addresses?
Fortunately, the DOL has provided guidance on how to handle these situations. If plan sponsors follow a four-step program but are still unable to obtain an election from participants, the accounts in question can be rolled over using the automatic rollover rules regardless of balance. The four steps are as follows:
- Use certified mail for the initial distribution notice;
- Check other plan records as well as those for other company benefit programs;
- Check with a designated plan beneficiary; and
- Use one of the governmental letter-forwarding services.
A fifth step that may be employed is to hire a locator service specializing in finding missing account holders. The expenses for all of these steps can be allocated to the accounts of the missing participants.
Conclusion
There are many options available to employers to address the account balances of former employees, and there is no “one size fits all” solution. As with most plan-related decisions, the appropriate solution depends on an employer’s specific facts and circumstances as well as the capabilities of the various service providers involved.
Although there is flexibility in how the plan is designed to accommodate these situations, the actual plan operation must adhere to the provisions written in the plan documents. Sponsors should work with knowledgeable providers who can coordinate the efforts of all parties involved to develop a practical and workable solution.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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