The nearly 45 percent of U.S. employees who leave behind their retirement accounts when they move to a new job are creating a multibillion-dollar headache for employers who have to manage these accounts.
According to one of the more reliable estimates, from Charles Schwab, 43 percent of assets held by 401(k) participants who left their jobs in the first quarter of 2008 had not been moved a year later. (The rest of those holdings either were rolled over into IRAs, taken as cash distributions or moved into new employer plans.)
It is estimated that there are 15 million so-called “orphaned” retirement accounts out there. That means that nobody has claimed them, or touched them in years and that plan sponsors have no way of reaching out to their owners.
The U.S. Department of Labor realized a few years ago that something had to be done to alleviate plan sponsors’ financial and administrative burdens when it came to these abandoned plans, so it gave companies leeway to dump any retirement accounts with balances less than $5,000. Plan sponsors can do this either by cash-out or by rolling those accounts over into an individual IRA that the sponsor would establish on the employee’s behalf.
Terry Dunne, managing director of automatic rollovers for Millennium Trust, an IRA provider based in Oak Brook, Ill., estimates that it costs between $25 and $35 per abandoned account, per year, to administer, a cost that is either borne by plan sponsors or other plan enrollees.
It doesn’t sound like much, but if you multiply that amount by 15 million abandoned accounts per year, the costs explode to between $375 million and $525 million.
In the end, if people leave their accounts with former employers until they retire, it could be 20 to 30 years that those accounts sit idle but must be maintained. The costs add up to billions of dollars.
Generally, retirement plans are created as a benefit to a company’s employees while they remain with the company, not for when they're gone. But the average employee attrition rate in the U.S. is 23 percent, Dunne said, and so the problem is big and getting bigger.
“Over the course of three to five years, if you kept everyone in the plan that has left, you’d have more former employees in the plan than actual employees; plans were never designed to provide benefits to former employees,” he said.
Finding missing participants
So what happens if you have a lot of missing participants in your plan with more than $5,000 in assets?
A retirement plan is required by law to continue maintaining those accounts until the plan holders reach full retirement age. The only escape route is if a plan is being terminated. Then, those assets need to be shifted off the books.
What's so magical about the $5,000 limit? According to Dunne, it was a number the Department of Labor felt was small enough that participants wouldn’t be angry when the money was transferred into an IRA or cashed out.
It’s best, of course, to keep track of former employees, because unfortunately for plan sponsors, they can’t just keep the money and forget about missing or unresponsive participants. They have a fiduciary responsibility to make sure each account holder continues to receive the same communication and education regarding their retirement plan, according to the Society for Human Resource Management.
Where matters get really complicated is when a company ceases to exist and needs to terminate its retirement plan. A plan can’t be terminated until all of the funds in it are distributed, but if the company ceases to exist and the trustees who managed the account also disappear, it makes it that much harder for employees to come back and locate past retirement accounts.
That’s where companies like Millennium Trust come in. These firms are hired to take control of the assets of the plan and to continue searching for missing participants. They have a number of tools at their disposal to keep looking for missing plan participants and, according to Dunne, Millennium Trust can usually find 90 percent of missing or unresponsive individuals.
Uncashed checks and monetary limbo
A big problem that gets rarely discussed is what plan sponsors can do about uncashed distribution checks. Companies across the country regularly send distribution checks to former plan participants. But if these former employees don’t cash the checks, that money remains in the employer’s retirement plan.
“Believe it or not there are billions of dollars in these uncashed types of situations,” Dunne said.
The solution to this is the IRA rollover. Otherwise, the plan sponsor continues to pay out money to maintain old accounts and they must hold enough money in reserve to pay out that money if past participants ever come back and claim their lost funds.
Another problem that crops up with distribution checks is that there is a tax withholding requirement. If a company decides to distribute $1,000 in assets to a former plan participant, the government typically gets $200 and the recipient gets $800. If the recipient doesn’t cash the check, the funds revert back to the plan sponsor, but the $200 withholding that was sent to the IRS does not. If the $800 is then rolled over to an individual IRA, the past participant may then have to figure out where the $200 went and get it back since rolling those funds over to an IRA is not a taxable event.
“The bigger the company, the more likely it is they use record-keepers to make the distribution. The company may not know that the money never got paid out, so that money sits in a large backroom somewhere, in limbo” until someone tries to find it, Dunne said.
He believes the Department of Labor needs to help plan sponsors figure what they can do so the money doesn’t get lost in the shuffle.
In the case of the uncashed check that gets rolled over to an IRA, plan sponsors should be responsible for making sure their former plan participants get back every dime that was in their retirement account, including requesting the withholding checks back from the IRS, he said.
“They need to undo their mistake completely. That would be best practice,” he said. “What people want is for the DOL to say, “I get that you did something wrong. Here’s what you need to do and we are OK with it.”
Millennium Trust is encouraging the DOL to focus more on this topic because it has become such a large problem.
“It does impact a lot of individuals who don’t even know they have money. It is not communicated to them they have money. It is almost like that money is escheated but they don’t have any notifications being sent that money is sitting in an account for them,” Dunne said.