A recent web seminar covered the topic of missing participants with Mercer experts Margaret Berger, principal, Princeton, New Jersey, Brian Kearney, principal, Washington, D.C., Norma Shaiara, principal, Washington, D.C.
Dealing with missing participants is a big issue for defined benefit (DB) and defined contribution (DC) retirement plans. Sponsors of ongoing retirement plans (including frozen plans) may need to rethink their procedures for tracking down missing participants in light of the Department of Labor’s (DOL)’s expanded audit initiative and Internal Revenue Service’s (IRS)’s recent informal guidance.
Over the last few years, Congress, the Governmental Accountability Office (GAO) and all three federal agencies that regulate retirement plans have been focusing on missing participants according to Shaiara. “This comes at the time of the silver tsunami, when Baby Boomers are retiring at a rate of ten thousand per day. This increasing number of participants turning 65 or 70.5 are required to take their defined benefit or defined contribution benefits.”
What types of retirement plans need to worry about missing participants? All Employee Retirement Income Security Act (ERISA) plans and tax-qualified plans including 401(a) and 403(b) plans. Most DB plans say that benefits for terminated participants will typically begin at the normal retirement age although the plan could be written to meet required minimum distribution rules (RMD) after age 70.5. Therefore, if a DB plan participant is missing at retirement age, there may be a failure to follow the terms of plan if the benefit isn’t paid out which could be a qualification problem under the tax code and could be a fiduciary breach under ERISA. For both DB and DC plans, RMDs generally must begin by 4/1 of calendar year after the year a participant turns 70.5 unless the participant is still working for the employer.
Terminating plans can’t wind things up and file a Form 5500 until all assets have been distributed, so finding missing participants can slow down a plan termination. Shaiara says, “For the past two years the DOL has increased audits nationwide focusing on whether benefits have begun on time to terminated, vested participants in ongoing DB plans. Generally, regulators say that plan sponsors need to make significant efforts to locate participants so that benefits are paid on time. Inadequate searches can lead to penalties under ERISA.”
Each of the federal regulators have their own rules about locating missing participants. Currently there is not necessarily any one thing a plan sponsor can do that would satisfy all three of the regulators.
The IRS provides the Employee Plans Compliance Resolution System (EPCRS) which has long included corrections principles for ongoing and terminated plans, both DB and DC plans. Plans need to take “reasonable actions” to locate missing participants as part of an EPCRS correction. The language was used recently in Revenue procedure 2016-51 which updates the comprehensive system of correction programs for sponsors of retirement plans that are intended to satisfy the requirements of Sections 401(a), 403(a), 403(b), 408(k), or 408(p) of the Internal Revenue Code, but that have not met these requirements for a period of time. Therefore, Shaiara says, “A plan can still fix problems under EPCRS, even with missing participants, so long as it takes reasonable action to locate them and when the participants show up, and the benefits due them are provided to them.”
In addition, some IRS guidance on finding missing participants can also be found on Form 5500 since 2015. Based on comments received in response to a Paperwork Reduction Act notice regarding the 2016 Form 5500 and Form 5500-SF, the Internal Revenue Service (IRS) announced that filers who have made a concerted effort to locate missing participants will face less of a reporting burden associated with the missing individuals.
Specifically, plan sponsors in the absence of other guidance, do not need to report on lines 4I of the Schedule H and I of the Form 5500 and 10f of the Form 5500-SF unpaid required minimum distribution (RMD) amounts for participants who have retired or separated from service, or their beneficiaries, who cannot be located after “reasonable efforts” or where the plan is in the process of engaging in such reasonable efforts at the end of the plan year reporting period.
On October 19, 2017, a memo from the IRS to its agents directed agents not to challenge DB or DC plan qualification for failing to make RMDs to miss participants, if a plan did ALL of the following: 1) Searched plan and related plan, sponsor, and publicly available records or directories for alternative contact information; 2)Used any of the flowing search methods: Commercial locator service, credit reporting agency or proprietary internet search tools for locating individuals; and 3)Attempted contact via certified mail to the last known mailing address and through appropriate means for any address or contact information including email and cell phones. They recently came out to say the memo extends to 403(b) plans as well.
For ongoing DC plans and for terminating DC plans Treasury bill 1.411(a)-11e offers guidance on forfeitures and suspensions for a long time in place. The limitation found in the Code Section 411 regulations (Treas. Reg. 1.411(a)-11(e)(1)) prohibiting forced distributions upon a DC plan’s termination where another “defined contribution plan” is maintained (and which direct that in that instance rather than a forced distribution, account balances of non-consenting plan participants be transferred to the other defined contribution plan), should only be applied to similar plans (i.e., maintaining another 401(a) plan after terminating a 401(a) plan or maintaining another 403(b) plan after terminating a 403(b) plan).
On August 14, the DOL released Field Assistance Bulletin (FAB) 2014-01, which provides additional guidance to plan fiduciaries of terminated DC plans with regard to missing participants. FAB 2014-01 requires that all of the following search procedures be exhausted before a plan fiduciary concludes its search for missing participants: 1) Send notices via certified mail; 2) Check related plan resources; 3) Consult the beneficiary of the missing participant; and 4) Use free electronic search tools—a new requirement. Search expenses may be charged to a missing participant’s account if this is consistent with ERISA and the plan’s terms. If these free services are not effective the plan sponsor must use services that are not free. The Labor Department expects plan sponsors to make efforts according to the size of the organization and overall plan assets involved and a cost/benefit analysis.
Starting this year, the Pension Benefit Guaranty Corporation (PBGC) has expanded its missing participant program. Beginning in January, terminating DC plans have had the option of transferring missing participants’ benefits to PBGC instead of establishing an individual retirement account (IRA) at a financial institution. Participant accounts will not be diminished by ongoing maintenance fees or distribution charges, and PBGC will pay out benefits with interest when participants are found. The enhanced program will make it easier for people to locate their retirement benefits after their plan terminates.
Based on current rules from all three regulators, here are what plan sponsors should do to find missing participants: Search all employer records; use certified mail; use more than one search method; conduct periodic searches; and keep records of when/how searches were done. Stay tuned for guidance from the IRS, DOL and PBGC or new legislation, i.e. The Retirement Savings Lost and Found Act.
When Missing Participants Are Found
What should plan sponsors do when they find missing participants? Berger says, “The answer depends on what type of plan the benefit is paid from and the age of the participant.”
DC plans are more straightforward. When you find the missing participant, you simply pay them out. The only wrinkle is if the former participant is older than age 70.5. This means that the required beginning date for RMDs has been missed as well as ongoing RMDs. Participants in both DB and DC plans are subject to these specific RMD rules and if they don’t start their benefits on time they are subject to an excise tax of 50% of the missed payments, paid by the participant. The IRS may waive the tax if the plan sponsor files under the Voluntary Correction Program and/or participants can request a waiver for the error.
To understand why missing participants are a thorny issue for DB plans plan sponsors need to understand the moving parts, such as vesting rules. Vested benefits cannot be forfeited after normal retirement date except under the benefit suspension rules and they apply to only active participants and not vested, terminated participants. “When I say they cannot be forfeited, that’s not the same as them not being postponed. Some DB plans allow participants to defer their benefits up to the required date which is the April after the participant turns 70.5, which allows the plan sponsor more time to find the missing participant,” Shaiara says.
The second complicating factor is the qualified joint survivor rule. A qualified joint survivor annuity provides a lifetime annuity to a participant and a survivor benefit of at least 50% to a surviving spouse. For a DB plan, a spouse must consent to any election other than a QJSA and the explanation of the QJSA must be provided 180 days before the annuity starting date meaning this deadline can be tricky for active participants but it can really be complicated for terminated, vested participants. If the participant has passed the normal starting date, it’s impossible to pay their benefit on time and provide the notice before the annuity starting date, unless the plan has a retroactive annuity starting date provision.
The IRS has said informally that without the participant’s valid election the plan will have to default to paying benefits in the form of a QSJA. This causes several problems particularly for plans that offer lump sums and participants are expecting to receive lump sums but they missed the deadline that they had forgotten about. This is also problematic for participants who spouses passed away post normal retirement starting date.
There is also the question whether not offering optional forms of distributions is permissible. Saying that they missed the deadline so they miss the optional form is very problematic. A retroactive annuity starting date (ASD) is one way around these issues. A DB plan does not have to provide for retroactive ASDs. If a plan wants to permit retroactive ASDs, the plan document must specifically provide for them. In addition, the participant must have the right to have benefits calculated as of the retroactive ASD or the current date and must affirmatively elect a retroactive ASD. A retroactive ASD is permitted only if several requirements are met.
The IRS offers two correction plans. The self-correction program (SCP) where there is no reporting to the IRS and no fee. This correction program is always available for insignificant errors and at times available to for significant errors. The Voluntary correction program (VCP) must be used if a plan wants a participant’s excise tax waived. It is streamlined for required beginning date failures and the back payments use the plan’s actuarial equivalent basis. A plan sponsor must explain how the failure occurred and why it won’t happen again.
There are three ways plan sponsors can ease administration and reduce errors. It’s difficult to deal with found participants in a DB plan. The best plan of action is to avoid this problem from the beginning. There are three steps plan sponsors can take that should improve their chances. First, follow the terms of the plan. Start benefits for terminated, vested participants at age 65. If the plan does not provide for a retroactive ASD, it should be amended to do so.
If a plan sponsor finds participants older than age 65 and younger than the RMD required beginning date, it can now pay them back and give them optional forms of distributions. Plans can also be amended so that terminated, vested participants can defer to the required beginning date with an auctorial increased benefit. Plan sponsors can also add forfeitures for missing participants and beneficiaries if they really cannot find someone, as long as the plan has a process in place where the benefits forfeited can be claimed if a participant is found.