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.
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.
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.
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.
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.
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.
- 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.
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.
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.