Missing Participants
Rev. 04/16/04, E-mail Alert 2004-8

THIS ARTICLE IS UPDATED BY DOL GUIDANCE ON MISSING PARTICIPANTS
OF OCTOBER, 2004 Click Here

When a terminated plan participant who has a vested account balance of less than $5,000 cannot be located, the plan sponsor will encounter difficulties in cashing out that individual. Locating and distributing vested benefits to missing participants can also be a problem when a retirement plan is being terminated. What steps are employers required to follow? Will the newly released automatic rollover regulations help to resolve these difficulties?

In both situations, the employer is legally required to take reasonable steps to locate the participant, or, if necessary, the beneficiary. Acceptable methods include the use of registered or certified mail to the last known address and the use of the government's letter-forwarding services described below. The employer may also use a private service for locating individuals as an alternative or additional method.

Cashing-out a Missing Participant in an On-going Defined Contribution Plan
The IRS Code permits a plan to “involuntarily” cash-out a participant who terminated employment and has a vested account balance (VAB) of less than $5,000. However, the plan administrator must notify the participant before the distribution is made and provide certain tax information with that notice. Spousal consent is not required for a cash-out under $5,000 in plans that are subject to the Joint and Survivor Annuity rules. The determination of the amount of the VAB is made at the time of the distribution. Thus, if the VAB should increase above $5,000, then the “involuntary” cash-out may not be made. Similarly, should the participant's VAB decrease below $5,000, an involuntary cash-out may be implemented.

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) permits a plan to incorporate a provision to exclude rollovers when determining the VAB. For example, if the participant, with an account balance of $23,000, had rolled in $20,000 and only had contributions of $3,000 while with the employer, the employer could exclude the $20,000 rollover and determine the participant's VAB to be $3,000 for involuntary cash-out purposes. However, the employer would be able to distribute the entire $23,000 amount.

If the participant cannot be located, the plan administrator must demonstrate due diligence in attempting to locate the participant. This is documented, as noted above, by special mailings, or availing itself of the governmental mail-forwarding programs or private locating services. In the event that these efforts fail, the plan document's missing participant provisions should be followed; and, under certain situations, this may include the authority to forfeit the account and reallocate the funds to the remaining plan participants. If forfeiture is permitted, should the participant request a distribution at a later date, the plan must have a provision to restore and distribute the forfeited funds to the formerly missing participant.

Plan Termination and Locating Missing Participants
Plan terminations present a different set of issues for the employer when dealing with missing participants because of the need to satisfy the general IRS requirement that terminating defined contribution plans distribute plan assets within 12 months of the termination date and the fiduciary duty under ERISA to protect plan participants and beneficiaries. This could be especially challenging where the sponsoring employer is also going out of existence. As in the cash-out situation, once the steps to locate missing participants have been taken, the plan document provisions should be followed. Thus, if the plan document includes a provision to forfeit and reallocate among the remaining participants, it should be followed. Alternatively, the plan document may permit the transfer of affected accounts to another retirement plan maintained by the employer [other than an employee stock ownership plan (ESOP)] or to transfer the account balances to IRA accounts set up on behalf of the missing participants. The plan document may empower the employer to use any reasonable method or combination of methods to distribute plan assets in an orderly and timely manner.

Note: Defined Benefit Plans have the option of remitting balances, regardless of the dollar amount, for lost participants to the Pension Benefit Guarantee Corporation upon a plan termination.

Cash-out Over $5,000 Permitted Upon a Plan Termination

Note that in a plan termination, the IRS permits distribution of balances over $5,000 without the participant's consent, provided all steps have been followed to locate the participant. This authority is granted to a defined contribution plan under Treas. Reg. 1.411(a)-11(e) provided that:

• The plan does not offer an annuity option as a form of payout;
  
• The plan is not a money purchase or target benefit plan;
  
• There is no other plan of the employer (with the exception of an ESOP);
  
• There is no other plan among any employer of a controlled group to which the employer belongs (with the exception of an ESOP); and
  
• Every effort has been made to locate the participant, including: IRS letter-forwarding program (Rev. Proc. 94-22); Social Security Administration letter-forwarding program; and/or hiring a private locator service.
  Click here for our FAQ on this subject.

The Other Available Options (and their Drawbacks) that the Employer May Consider in the Plan Termination Situation

1. Establishment of an IRA
   Although the idea of establishing an IRA in the name of a missing participant is permitted under the law, there are two practical impediments: First, most institutions will not open an IRA without the individual's signature. Second, the investment to be selected for the IRA must be prudent and the DOL has not yet defined that concept in final regulations. The recently proposed regulations for transferring assets to an IRA would provide the Fiduciary with a safe-harbor method for moving the funds to an IRA assuming the 6 points of the safe harbor method are followed. However, the proposed regulations will only become effective 6 months after the final regulations are published in the Federal Register. Click here for our article on the proposed regulations.
   
   
2. Issue a Check to Last Known Address
   This option is one of the least favorable as the check may be returned and the assets will then become subject to the abandoned property rules under state law. In a 1994 ruling, the DOL stated said that escheat was not appropriate for ERISA assets; however, the courts have not resolved this issue as yet. Further, since the distribution will be taxable, the participant will not know to include the distribution on the Form 1040, until the IRS matches the Form 1099R to the Form 1040 and charges taxes (and penalties) for the year in which the distribution occurred. There is also the question whether the notice requirements are satisfied. If the plan administrator receives everything back because of a bad address, is the participant deemed to have received the required pre-distribution notices? The answer is unclear.
   
   
3. Forfeiting Missing Participant's Funds to the Plan
   If the plan document provides such an option, the employer may forfeit the missing participant's funds to the plan and reallocate them according to the provisions of the document. However, if the missing participant subsequently claims the funds, there may be no employer or retirement trust to restore them.

Note: Processing the distribution at 100% withholding of the lost participant's benefit has been done by some practitioners over the years. The Internal Revenue Service has recently stated that this is not provided for in the Code or Regulations. Therefore, the IRS does not sanction this method. The Department of Labor (DOL) has also “unofficially” stated that it would be a breach of fiduciary duty to take this action.

IRS and Social Security Programs for Contacting Missing Participants

The IRS will search its database for a recent address and forward the inquirer's letter to the missing person. The IRS is precluded from giving addresses or any other information to the individuals who have initiated a search. The IRS will not disclose whether the correspondence has been delivered. Letters returned as undeliverable are destroyed without informing the sender of the action taken. For detailed information, access the IRS website by clicking on the link:
http: //www.irs.gov/retirement/article/0,,id=110106,00.html.

The Social Security Administration program is similar to the IRS program. For further information, access the Social Security Administration website by clicking on the link:
http://www.ssa.gov/foia/html/ltrfwding.htm.

Because of privacy considerations, the governmental mail forwarding programs cannot provide absolute assurance that the missing participant has been actually contacted.

Bill Grossman, QPA