SunGard Relius

Probably the most troublesome issue facing employers and retirement plan practitioners is the issue of lost participants. Lost participants: (i) increase the plan’s annual administrative expenses and fiduciary responsibility; (ii) may cause the plan to be subject to the audit requirement because the number of participants exceeds the large plan threshold; and (iii) can cause substantial delays in terminating a plan. Therefore, employers and practitioners need to be aware of the methods available to resolve or minimize the lost participant problem.

After many years of ignoring the issue, the IRS, DOL and Congress have provided some options to assist administrators in dealing with lost participants. In addition, practitioners and companies have designed other methods. The following explanation discusses the various methods available:

IRS Missing Participant Program. The IRS will assist a plan in locating lost participants. The program really is a letter-forwarding program. The plan sends to the IRS the name and social security number of the lost participant, along with a distribution notice enclosed in an envelope. The IRS then forwards the letter to the last known address the IRS has on file. However, the IRS will not provide the plan with the address of the lost participant nor with the results of its efforts. If the plan sends 50 or more letters for the IRS to forward, the IRS imposes a fee. See Rev. Proc. 94-22. The Social Security Administration has a similar program.
Note: Administrators have reported mixed results in using this program.

Private Locater Services. There are now several private locater services that plan administrators may retain to assist in locating lost participants. Generally, these companies advertise and communicate via the internet. The main advantages of using a private search company are speed and minimal cost. Often a search takes only a few minutes using the internet. Many practitioners have reported great success in using these services.

Escheat or Unclaimed Property Laws. Some practitioners, after making several attempts to locate participants, simply take advantage of state escheat or unclaimed property laws and transfer the lost participants’ accounts to the state. Unfortunately, the DOL has ruled that ERISA preempts state escheat laws. Therefore, practitioners should not escheat lost participants’ accounts to the state if the plan is subject to ERISA. See DOL Advisory Opinion 94-41A.

Default Rollover. One of the more promising methods for resolving the lost participants’ accounts is the default rollover. Under Rev. Rul. 2000-36, the IRS ruled that a plan may provide for a default direct rollover of a participant’s account to an IRA if the account is distributable and the participant does not affirmatively elect make a direct rollover or to receive a cash payment. An account is distributable if (1) the account does not exceed $5,000, or (2) the participant has attained the later of age 62 or the plan’s normal retirement age. Therefore, the default rollover is available for participant accounts not exceeding $5,000, and for larger accounts where the participant has attained the later of age 62 or the plan’s normal retirement age. Since most lost participants’ accounts are less than $5,000, the default rollover should be a valuable tool in distributing the lost participant’s accounts. Unfortunately, the default rollover is not widely used at present because of the concerns of the financial institutions regarding (1) the responsibility for the investment of the rollover, and (2) the legality of establishing an IRA without the participant’s signature.

As part of EGTRRA, Congress enacted a provision requiring a plan to roll over the accounts of participants that exceed $1,000 (but do not exceed $5,000) and are distributable if the participant does not elect to roll over the account directly or to receive the distribution. The new provision, however, is not effective until the DOL issues guidance. EGTRRA requires the DOL to issue this guidance by June 7, 2004. The guidance is intended to relieve legal and fiduciary concerns of the financial institutions. Specifically, the guidance will provide safe harbors for the investment of the default rollover. Although the new default rollover provision will not solve the lost participant problem for the smallest of the lost accounts (up to $1,000), many practitioners are hoping the DOL guidance will provide sufficient comfort to the financial institutions so that they will also accept small default rollovers.
Note: If a plan can find a financial institution that accepts default rollovers, the plan can take advantage of the IRS ruling on default rollovers.

Forfeiture. Some plans (including all three of Corbel’s documents: Corbel, PPD and FDP) include a provision that permits a plan to forfeit a lost participant’s account if it is distributable. Generally, the provision requires the plan to send a registered letter with return receipt to the participant. If the letter is returned to the plan, the plan waits for a period of time (e.g., 6 months) and then forfeits the account. The forfeiture approach is a very effective and efficient method for dealing with lost participants. If the lost participant is later located, the plan provides for a restoration of his/her account. The restoration first comes from current year forfeitures. If the forfeitures are insufficient, the employer must make an additional contribution to the plan.
Note: Once the DOL default rollover provision goes into effect, the plan only may use the forfeiture/restoration approach for accounts that do not exceed $1,000.

100% Income Tax Withholding. One approach some practitioners have used in resolving the lost participant problem is to withhold income taxes in the amount of 100% of the distribution. While some practitioners continue to use this approach, IRS and DOL officials recently have indicated that this technique is inappropriate and may violate ERISA. Therefore, practitioners should instead consider using one of the other approaches.

PBGC. For defined benefit plans subject to PBGC insurance, the PBGC permits the plans to transfer the benefits of lost participants to the PBGC. Unfortunately, this approach is not available to defined contribution plans.

Terminating Plans. For a plan that does not address the lost participant problem until the plan terminates, the plan may find its options limited. For example, if the plan has distributed the accounts of all the participants with the exception of the lost participants, the plan may find it impractical to use the forfeiture method. The plan may need to rely on one of the other approaches. In many circumstances, plan termination can make some participants’ accounts distributable, and therefore eligible for one of the lost participant approaches. A profit sharing plan that is not subject to the joint and survivor annuity requirements can force-out accounts that exceed $5,000 upon plan termination. If the plan is subject to the joint and survivor annuity requirements, the plan should be able to purchase an annuity to allow the plan to terminate.

ERISA §404(c). A plan that provides for participant direction of investment will not have ERISA §404(c) protection with respect to lost participants because such participants do not provide any investment direction. Accordingly, the plan will need to develop an investment strategy for such accounts until they are distributed or forfeited.

A plan with lost participants should take steps to eliminate these accounts to minimize administrative complexity and cost and to reduce fiduciary exposure to liability. At present, the above options comprise the menu that the plan sponsor should review in determining how to rid the plan of lost participant accounts or at least to reduce the number of these accounts. Any option taken should be consistent with the plan language (if any) addressing lost participants.

401(k) and Form 5500 Workshops
If you would like to discuss this issue further, it (and several other tough issues) will be one of the topics in our 401(k) and Form 5500 Workshops.