Tax withholding and reporting on escheated funds

[Oh so SIMPLE]

If a plan chooses to hand over the benefits of lost participants to the state escheat program, so that the plan can wind up and finish the termination of the trust, do you withhold 20% for federal tax withholding and report the whole amount as taxable income to the lost participant (i.e., a Form 1099-R with the lost participant's name, Soc Sec Number, and last known address)? Or do you simply hand 100% over the state, and not mention it to the IRS?

Also, how do you report those funds on the final Form 5500?

[Jim Norman]

Are you familiar with DOL Field Assistance Bulletin 2004-2? Escheat is not the DOL's preferred option, though it is permissible in a plan termination situation, though DOL typically would prefer to see the funds sent to an IRA on behalf of the missing participant. From the FAB:

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In our view, plan fiduciaries must always consider distributing missing participant benefits into

individual retirement plans (i.e., an individual retirement account or annuity).12 Establishing an

individual retirement plan is the preferred distribution option because it is more likely to preserve

assets for retirement purposes than any of the other identified options.

[snip]

In deciding between distribution into a state unclaimed property fund and distribution into a

federally insured bank account, we believe that a plan fiduciary should evaluate any interest

accrual and fees associated with a bank account against the availability of the state unclaimed

property fund’s searchable database that may facilitate the potential for recovery. In any event,

transfer to state unclaimed property funds must comply with state law requirements.

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That said, if you do escheat, the FAB specifically says that it is in fact a plan distribution and that the assets are no longer plan assets under ERISA. The FAB does not address withholding, but on this basis I would do the normal 20% plus state as applicable.

If you decide to do an IRA rollover, Penchecks offers missing participant IRAs. Full disclosure, I am a Penchecks shareholder.