State escheat laws - pre-empted by ERISA?

[My 2 cents]

Should qualified ERISA retirement plans have to escheat any funds to the sponsor's state of domicile or should the state escheat laws be treated as pre-empted by ERISA?

In a defined contribution plan, shouldn't amounts that cannot be paid for an extended period of time be treated as forfeitures, to be reallocated to the other participants? In a defined benefit plan, shouldn't such amounts also be treated as forfeited, reducing future employer contributions?

[david rigby]

Since a Yes/No answer might be problematic, I'll get the discussion started (sorry, no chance to check EOB):

1. ERISA does pre-empt escheat laws w/r/t account/accrued benefit in a qualfied plan, but not w/r/t an (apparently abandoned) IRA.
2 and 3. Might depend on plan provisions.

I'm sure other readers have more input.

[MoJo]

I agree with David - but I know that sme have taken the position that once a "distribution" has been processed and the "check" is un-cashed (but remains in the payor's checking account), that it can be escheated after the prescribed period of time.

This of course would only apply to "cash out" distribution and not balances in excess of $5,000 which couldn't be distributed without consent (absent a plan termination).

I happen to disagree that such funds can be escheated as simply moving the balance into a checking account is does not remove the assets from the "plan" (despite what some recordkeepers claim) and merely puts the plan assets in another vehicle for delivery to the participant. Failure to deliver (meaning actually transferring the assets TO THE PARTICIPANTS CONTROL (e.g. cashing the check) means the assets should be redeposited into the plans trust and dealt with per the terms of the plan. Forfeiture is an option, but as far as I know, one actually with "authority" but one the regulators seem to "tacitly" accept (at least, I've heard of no action against plan sponsors or others for doing so)....

[mbozek]

Under DOL opinion letters State laws requiring escheat of property to the state are preempted by ERISA. However, plans can voluntarily escheat benefits to state abandoned property funds if the state will accept them.

IRS reg 1.411(a)-4(b)(6) permits a plan to forfeit vested benefit of any participant when the benefits become payable if the participant cannot be located subject to restoration if the participant later appears. This provision prevents a plan from violating the requirement that MRDs must commence at 70 1/2. As it is 99% of missing participants never claim benefits usually because they are deceased. Question is whether such a provision is in the plan.

[Belgarath]

I will be sooooooo happy when the PBGC (assuming the program is something that can be administered REASONABLY) will finally accept funds for missing participants. If done right, this will make life a whole lot easier for employers and TPA's. Bring it on!

[shERPA]

The plan should follow the guidance of DOL FAB 2004-02 as updated and replaced by FAB 2014-01, and of course the plan document provisions.

There are firms that will assist in fulfilling the search requirements and set up a missing participant IRA (the DOL's preferred option).

Not looking forward to the PBGC taking this on, as it will no doubt be more difficult to deal with a bureaucracy than it is to deal with a private firm seeking to satisfy its customers. But because PBGC will be the 800 pound gorilla if/when it does take this on, it will probably displace private sector providers.

[mbozek]

Why should the plan transfer assets to a missing participant IRA and have the assets eaten up by custodial fees? Better to just forfeit the benefits and use then to pay admin expenses. Isnt an IRA for a missing participant limited to a certain amount? Check the SS master death registry to find out of the participant is dead.

[Mike Preston]

How would you suggest one can check the SS master death registry?

[MoJo]

Why should the plan transfer assets to a missing participant IRA and have the assets eaten up by custodial fees? Better to just forfeit the benefits and use then to pay admin expenses. Isnt an IRA for a missing participant limited to a certain amount? Check the SS master death registry to find out of the participant is dead.

Simply put, because if you move them to an IRA - THEY ARE OUT OF THE PLAN AND NO LONGER A POTENTIAL PLAINTIFF against plan fiduciaries. One could argue that the only remaining liability for the plan fiduciaries is the decision to put the account with the selected IRA custodian - but the DOL provides guidance on how to do that - and once you've done that, the "statute of limitation" does begin to run.

Fees taken by the IRA custodian are NOT the responsibility of the plan fiduciaries. It is a classic case of, as a participant, "you snooze, you lose" BUT that isn't the plan's concern.

I have a problem with "forfeiting" subject to later restoration. Restore what? Only the principal forfeited? What about lost earnings? IF the missing participant is STILL a participant, does not the fiduciary have a continuing obligation to make the assets productive (trust law 101)? Can not the participant come back years later and demand that the account be restored with investment earnings? The interesting thing about "participant directed" 401(k) plans is that the trustee/fiduciaries are ONLY relieved of investment loss liability IF the participant ACTIVELY manages the account. If they don't, a solid argument can be made that the fiduciaries have an obligation under ERISA to manage the money prudently....

[mbozek]

Its highly unlikely that a participant who has not contacted the plan for benefits by age 70 1/2 is going to apply at a later date. SS sends a statement of vested benefits that are payable under a qualified plan at the earlier of when an employee applies for SS or attains 66. If the participant has not applied for benefits 4 1/2 years later its unlikely they are alive. As I understand it the notice is provided to the spouse of a deceased worker.

The employer can determine if the employee is deceased by checking the SS Death registry which is available to participating employers as a means to verify whether a SS number belongs to a deceased individual. In the past it was available to check the status of former plan participants but I don't know if SS still allows it to be used for this purpose. If death registry is not available the plan can pay a locator service to determine if the participant is alive for a nominal fee. Its no different than the searches used to locate missing heirs of decedents.

I don't agree that its more prudent to transfer a missing participants vested benefit to IRA because the custodial fees will eventually eat through the account balance since the assets will be invested in MM fund. The optimal course of action is to forfeit the funds under the plan subject to restoration if the participant returns at a later date which guarantees return of 100% of the account balance. The plan could credit the account with a rate of return equal to inflation in the unlikely event that the missing participant ever shows up.

In the unlikely event that a missing participant returns to claims the benefits the door swings both ways- Forfeiting the account balance at MRD could prevent a decline to as low as 0 if the investment was in the wrong sector which will prevent the participant claiming that the plan acted imprudently by not moving the funds to a neutral investment.

[QDROphile]

MoJo:

Please discuss any authority you have for the statement below. I was under the impression that the plan fiduciary has an obligation to choose and IRA that is reasonable at the time of initiation, which includes reasonable fees. Even reasonable fees can eat up a low balance, given that permitted investments include low interest rate options, but IRA maintenance fees are generally quite low. I think it is an overstatement that the plan fiduciary has no responsibility

"Fees taken by the IRA custodian are NOT the responsibility of the plan fiduciaries."

[MoJo]

QDRO: Quite simply, the IRA is NOT a plan asset, so transactions within the IRA are not part and parcel of the plan fiduciaries responsibility. The ONLY fiduciary impact of the IRA is the selection of the IRA custodian (which may entail looking at the fees charged AT THE TIME THE CUSTODIAN IS SELECTED AND/OR DISTRIBUTIONS TRANSFERRED TO THE IRA. What happens later is external to the plan, and therefore not a fiduciary concern.

The obverse is actually the question to ask: Under what provision of ERISA does a fiduciary have responsibility for assets once they have left the plan and are beyond the control of the plan/fiduciaries? There is no such section of ERISA, and therefore no responsibility attaches to the plan fiduciaries after the prudent selection of the custodian.

Check with "Inspira" - a Pittsburgh based IRA recordkeeping/technology company that is one of the few that will accept small balance cash-outs and charge $25 to $50 per year on small balance accounts. They've done extensive research on the issue, and probably would share it if you asked.

[MoJo]

mbozek says:

I don't agree that its more prudent to transfer a missing participants vested benefit to IRA because the custodial fees will eventually eat through the account balance since the assets will be invested in MM fund. The optimal course of action is to forfeit the funds under the plan subject to restoration if the participant returns at a later date which guarantees return of 100% of the account balance. The plan could credit the account with a rate of return equal to inflation in the unlikely event that the missing participant ever shows up.

The problem, mbozek, is that it is ONLY the fiduciaries' responsibility to prudently select an IRA custodian, not to monitor what happens in the account AFTER the assets have moved out of the plan - and the law specifically allow cash-outs of small balance subject to the auto-rollover provisions.

Getting small balances out of the plan is generally a good thing as it removes "expense" from the plan with little or no revenue impact and removes a potential plaintiff from the plan. If you keep the participant "in the plan" albeit forfeited, I think you run HUGE risks of lost earnings if you don't keep them invested (prudently) as is the obligation of the fiduciaries. Forfeiting the participant essentially means NO EARNING - and that mean as much of a loss as charging fees against an IRA balance. Indeed, the DOL has indicated years ago that it is perfectly permissible to charge terminated plan participants fees to offset the costs of their continued participation in the plan when actives aren't charged those fees. Same thing as an IRA custodian charging a fee for account maintenance after assets have left the plan....

[My 2 cents]

Is it not more or less standard procedure in defined contribution plans that any amounts forfeited are reallocated among the other participants (or possibly spent to cover expenses)? In either case, wouldn't there be no lingering fiduciary obligations to the missing participants with respect to investment of the assets they were treated as having forfeited because those assets have, in effect, been spent (leaving nothing to be invested)?

[MoJo]

Is it not more or less standard procedure in defined contribution plans that any amounts forfeited are reallocated among the other participants (or possibly spent to cover expenses)? In either case, wouldn't there be no lingering fiduciary obligations to the missing participants with respect to investment of the assets they were treated as having forfeited because those assets have, in effect, been spent (leaving nothing to be invested)?

Until someone returns and demands a restoration of their account balance. "Forfeiture" is a convenience to the plan and it's fiduciary, and in my mind does NOT remove the participant from the plan for purposes of removing the fiduciary obligations. A participants cannot be "removed" from the plan, but then be "restored" to the plan, without being a participant during the absence.

It's a question of competing "prudence" requirements - which is worse - pulling them out of the plan and putting them into a "prudently" selected IRA custodian who then charges maintenance fees against the account, or "forfeiting" them and disallowing the productive investment of those assets over possibly an extended period of time.

In either case, the "participant" loses. In my mind, removing them from the plan at least starts the statute of limitations running - which NEVER starts if the balance is forfeited subject to restoration.

Fiduciaries have a duty to make the assets productive. Forfeiting the balance would not, IMHO, comply with that very basic obligation.

[jpod]

Is it a big deal to keep the account in the plan, perhaps invested in the appropriate QDIA, until termination of the plan or the participant or his beneficiary appears? Is risk of disqualification due to non-compliance with the MRD requirement a serious risk if you can't find the participant? If you do a prudent and thorough search for the participant once, do you have to ever do it again absent new information brought to your attention?

[My 2 cents]

In any event (to return to the original subject), whether one chooses to deal with missing participants via forfeiture (restored upon the participant coming forward) or transfer to an IRA, is it agreed that nothing should be escheated to the state from an ERISA plan? That a sentence in the plan section dealing with missing participants that says “However, regardless of the preceding, a benefit which is lost by reason of escheat under applicable state law is not treated as a forfeiture for purposes of this Section nor as an impermissible forfeiture under the Code.” is essentially meaningless because any state escheat law purporting to be applicable to a qualified ERISA plan is necessarily pre-empted and thus not applicable?

[david rigby]

Its highly unlikely that a participant who has not contacted the plan for benefits by age 70 1/2 is going to apply at a later date. SS sends a statement of vested benefits that are payable under a qualified plan at the earlier of when an employee applies for SS or attains 66. If the participant has not applied for benefits 4 1/2 years later its unlikely they are alive.

Maybe. My experience with "missing participants" is not deaths, but more likely the person has returned to his/her native country.

[MoJo]

Is it a big deal to keep the account in the plan, perhaps invested in the appropriate QDIA, until termination of the plan or the participant or his beneficiary appears? Is risk of disqualification due to non-compliance with the MRD requirement a serious risk if you can't find the participant? If you do a prudent and thorough search for the participant once, do you have to ever do it again absent new information brought to your attention?

As a lawyer, I think it's a big deal. Is it "prudent" to "un-invest" a participant and essentially put them in limbo? I can't think of any justification for that - especially considering the law allows for forced cash-outs of balances less than $5k that removes them from the plan PERMANENTLY.

I think the issue is that some think that "forfeiting" a missing participant "subject to restoration" is removing them from the plan. I don't see them as being removed from the plan. Removing a participant from the plan entails elimination of ALL rights they have under ERISA. The "subject to restoration" means that they really still have an interest in the plan, and therefore are still participants, who are due the protections of ERISA, including the duty of prudence by the plan fiduciaries.

Let me repeat that:

"The "subject to restoration" means that they really still have an interest in the plan, and therefore are still participants, who are due the protections of ERISA, including the duty of prudence by the plan fiduciaries."

There is nothing I have ever seen that says you can "suspend" a participant's rights under ERISA simply because you can't find them and choose as an administrative matter to un-invest them and forfeit their balance (that is, using it for other plan purposes) subject to their reappearing and having a "springing" interest in being treated as a participant again.

You are either a participant or you are not. If you are not a participant, you have NO RIGHTS whatsoever with respect to the plan (ever and forever - except for claims that may relate to a prior period when you were a participant).

As far as the other issues (missed RMDs, etc.) there are mechanisms to deal with that as they arise that will preserve plan compliance with the Code.

[SavingsRUS]

Missing participant passed away some time ago. No beneficiary designation, and no relatives or spouse. Benefit goes to estate under plan terms. Unable to locate estate. May benefit escheat to state?

[Peter Gulia]

Observing these different views about whether it makes sense to pay a distribution (whether to an IRA custodian, or under an abandoned-property regime) or account for a right to restore a forfeiture, I wonder whether a typical plan's administrator has a choice.

Does a typical prototype or volume-submitter document grant the administrator discretion to decide the mode for paying or forfeiting a benefit?

Or does a typical plan state the provision?

[My 2 cents]

Key point is that it is never mandatory to escheat any funds to the state from the plan.

[SavingsRUS]

Thanks, 2 cents, but *how* exactly may a benefit escheat to the state when even the estate cannot be located?

[My 2 cents]

Thanks, 2 cents, but *how* exactly may a benefit escheat to the state when even the estate cannot be located?

Is a puzzlement! But someone said above that it is permissible for the plan to voluntarily escheat funds to the state. "Under DOL opinion letters State laws requiring escheat of property to the state are preempted by ERISA. However, plans can voluntarily escheat benefits to state abandoned property funds if the state will accept them."

Maybe that would be a solution.