If an employee leaves after vesting but before the plan’s retirement age, benefits generally stay with the plan until the employee claims them at retirement. Several situations could change this, though, leaving employers with the problem of handling unclaimed funds:
- Plan terminations: To terminate a plan, an employer must convert remaining funds to cash and distribute them as soon as possible.
- Plan clean-ups: If employers want to stop paying unnecessary administrative costs, they may cash out small accounts (generally less than $5,000) that former employees leave behind. The employer or its plan administrator must convert balances to cash, pay the appropriate amount to the IRS and roll the remainder into an IRA. For amounts less than $1,000, the plan administrator can send a check for the remainder to the former employee’s last known address.
- Uncashed checks: Sometimes, an employee requests or expects a cash-out, but the check remains uncashed.
If a plan participant can’t be located, what does a plan sponsor do with his/her abandoned funds? All states require financial institutions, including insurers, brokerage firms and other firms that manage retirement plans, to report when personal property has been abandoned or unclaimed after a period of time specified by state law — often five years. Before a plan account can be considered abandoned or unclaimed, the plan must make a diligent effort to try to locate the account owner. If the plan is unable to do so, and the account has remained inactive for the period of time specified by state law, the plan must report the account to the state where the account is held. The state then claims the account through a process called “escheatment,” whereby the state becomes the owner of the account.
As part of the escheatment process, the state will hold the account as a bookkeeping entry, against which the former account owner may make a claim. States tend to sell the securities in escheated accounts and treat the proceeds as state funds. When a former account owner makes a valid request, however, the states will normally provide the former owner with cash equaling the value of the account at the time of escheatment.
Employers can avoid escheat on plans governed by ERISA by adopting plan language that expressly states that plan participants who the plan determines to be lost after a specified period will forfeit their funds. This allows employers to retain these funds, which they can use to offset plan administration expenses. Wouldn’t you rather have the balances of missing participants and be able to apply them toward plan administration expenses, rather than seeing them go to the state?