In October 2004, the Department of Labor issued Field Assistance Bulletin No. 2004–02 (the “Bulletin”) dealing with fiduciary duties with respect to missing participants in terminated defined contribution plans. The missing participant program of the Pension Benefit Guaranty Corporation applies to defined benefit plans.
Background and Applicable Law
The problem of missing participants is particularly acute in terminated defined contribution plans. Upon termination of a defined contribution plan, all affected participants immediately become fully vested in their account balances. In order to “wind up” the plan and complete the termination, all plan assets must be distributed as soon as administratively practicable after the date of termination. The Internal Revenue Code (the “Code”) requires a plan administrator to contact all participants prior to any distribution and seek directions concerning the distribution of their account balances. Some plan participants may be unresponsive to such requests from the plan administrator, therefore making it impossible to wind up the plan.
The Department of Labor has held that the decision to terminate a plan is generally a settlor function rather than a fiduciary function relating to plan administration; nonetheless, the steps taken to implement the decision to terminate are governed by the fiduciary responsibility provisions of the Employee Income Retirement Security Act of 1974, as amended (“ERISA”). See Adv. Op. 2001–01A (January 18, 2001) and Letter to John N. Erlenborn from Dennis M. Kass (March 13, 1986). In such a context, two specific fiduciary issues arise:
- locating a missing participant; and
- distributing the account balance when efforts to communicate with the missing participant and obtain a distribution election are unsuccessful.
Locating Missing Participants:
In the Bulletin, the Department of Labor takes the position that, to fulfill its fiduciary obligations in attempting to locate missing participants, a plan administrator must use certain specified search methods. Additional search methods may be necessary with regard to a particular participant; in determining whether to use such additional methods, the plan administrator must consider the size of the participant’s account balance and the expenses involved in attempting to locate the missing participant. Expenses incurred in attempting to locate a missing participant may be charged to the participant’s account; however, the amount of expenses allocated to the participant’s account must be reasonable and the method of allocation must be in accordance both with the terms of the plan and with the plan fiduciary’s duties under ERISA.
Required Search Methods
The Bulletin expresses the Department of Labor’s view that certain search methods involve such nominal expense and are potentially so effective that a plan fiduciary must always use them, no matter what the size of the missing participant’s account balance. The fiduciary cannot distribute a missing participant’s account balance under one of the permitted distribution options described below unless all of the required methods prove ineffective in locating the participant. The fiduciary does not have to use all of the required methods if one or more prove successful in locating the participant. The required search methods are:
- Certified Mail.
- Check Related Plan Records. Many times the employer or another plan of the employer (for example, a group health plan) may have more up-to-date information concerning a particular participant than does the terminated defined contribution plan. Accordingly, plan fiduciaries of the terminated plan must ask both the employer and the administrators of related plans to search their records for a current address for a missing participant. In order to avoid privacy concerns, the fiduciary may ask the employer or plan administrator to contact, or forward a letter to, a participant on behalf of the terminated plan.
- Check with the Participant’s Designated Beneficiary.
- Letter Forwarding Service. Both the Internal Revenue Service and the Social Security Administration offer letter forwarding services. A plan fiduciary must choose one.
Other Search Options
Depending on the facts and circumstances, a plan fiduciary may also need to use additional search options. Additional methods include:
- Internet Search Tools.
- Commercial Locator Services.
- Credit Reporting Agencies.
If the cost of the additional option is to be charged to the participant’s account, the plan fiduciary will need to consider the size of the participant’s account balance in relation to the cost of the services when deciding whether to use the option.
If, after using the search methods outlined above, the plan fiduciaries are unable to locate a missing participant or to obtain directions concerning the distribution of benefits, they will need to consider various distribution options in order to distribute the plan benefits and complete the plan termination. Certain fiduciary considerations are relevant to the various options. The primary goal of the Department of Labor in its analysis of these considerations is the preservation of assets for retirement purposes.
Individual Retirement Plan Rollovers
A rollover into an individual retirement plan (either an individual retirement account or an annuity) is the preferred method of distribution and must always be considered by a plan fiduciary. Such a rollover is more likely to preserve assets for retirement purposes than the other distribution options because it results in a deferral of income tax and avoids the imposition of 20% income tax withholding and the 10% tax for premature distributions. The choice of an individual retirement plan raises fiduciary issues as to the choice of a trustee, custodian or issuer as well as the selection of an initial investment. Treasury regulation Section 2550.404a–2 provides a safe harbor for plan fiduciaries when selecting individual retirement plan providers and initial investments in connection with the rollover of certain mandatory distributions of $5,000 or less for participants who leave an employer’s workforce without making a distribution election. In the view of the Department of Labor, the circumstances to which the safe harbor regulation applies are similar to those confronting fiduciaries of terminated defined contribution plans. Accordingly, in the case of missing participants, plan fiduciaries of a terminated defined contribution plan who choose investment products that are designed to preserve principal, and who comply with the relevant provisions of the safe harbor, will be treated as satisfying their fiduciary duties. For a complete description of the safe harbor regulations, see our October 2004 edition.
If a plan fiduciary cannot find an individual retirement plan provider that will accept a rollover distribution on behalf of a missing participant, other alternatives may be considered. These alternatives, however, will lead to income taxation, mandatory income tax withholding and the penalty tax for premature distribution.
- Federally Insured Bank Account. This account must be in the name of the missing participant, and the missing participant must have an unconditional right to withdraw funds from the account. The plan fiduciary must give appropriate consideration to information concerning selection of a bank and an initial interest rate.
- Escheat to State Unclaimed Property Funds. The fiduciary may consider transferring account balances to state unclaimed property funds in the state of each participant’s last known residence or work location. Such a distribution would constitute a plan distribution and end both the missing participant’s status as a participant in the plan and the status of the funds as plan assets under ERISA.
100% Income Tax Withholding:
Not an Acceptable Option
Some plan fiduciaries follow the practice of imposing 100% income tax withholding on the benefits of missing participants. Such a practice has the effect of transferring the benefits to the Internal Revenue Service (the “IRS”) on the theory that the 100% withholding would result in the withheld amounts being matched or applied to the missing participant’s income tax liabilities, resulting in a refund of any excess. The IRS, however, has indicated that 100% withholding will not necessarily result in such a matching or application.
The Department of Labor has concluded that 100% income tax withholding is not in the interest of participants and beneficiaries and violates ERISA’s fiduciary requirements. This method, accordingly, should not be used by plan fiduciaries.