Terminated Participants Require Fiduciary Care

ERISA dictates a list of best-interest requirements when managing terminated plan participants.

What do your sponsor clients need to know about terminated plan participants?

“For ERISA [Employee Retirement Income Security Act] purposes, a terminated employee is still a participant in the plan,” says Jeffrey Capwell, a partner at McGuire Woods and leader of the firm’s employee benefits and executive compensation group. “The employer still has all of the same fiduciary and other ERISA obligations for a terminated participant that has an account balance in the plan as it does for active participants who have an account balance under the plan.”

But, he adds, “there may be distinctions in their employment capacity and what kinds of obligations outside of ERISA that the employer may have with respect to that person.”

For instance, Capwell says, the plan adviser can help the sponsor to structure its loan provisions to prevent most terminated people from obtaining loans under the plan. Most differences in treatment, though, relate to pushing funds out of the plan, not keeping money in.

If a terminated participant reaches the plan’s normal retirement age, for example, he could be required to take a distribution then. Alternate payees, too, such as those under a qualified domestic relations order (QDRO), could be forced to take a distribution. There are some limited, technical reasons that might allow for a forced distribution of the participant’s accumulated benefits, many of which are tied to the amount of the individual balance.

“You could force them to take a distribution under the plan if their account balance is $5,000 or less,” Capwell says. “If their account balance is between $1,000 and $5,000 and they don’t consent to the distribution, then you have to roll it automatically into an IRA [individual retirement account]. So you can, depending on the size of their account balance, roll them or force them out of the plan.”

There is one hiccup, though, with that $5,000 threshold: “If the participant does not consent to that involuntary cash-out, and the balance is above $1,000, then the sponsor is required to go out and actually transfer that money into an IRA for them,” he says. Plan sponsors may be resistant exercising this discretion, though some rules protect the employer from future potential liability for the rollover of that money, Capwell points out

There’s a relatively small pool of providers that are willing to accept small rollovers, so that provider search can be a complicating factor of using a $5,000 cash-out limit. “As a result,” he says, “many employers use a cash-out limit of just $1,000, in order to avoid that.” Plan advisers can help their clients to implement the lower limit.

NEXT: Participant communications 

“One thing that’s very important, if you’ve got a terminating participant, you should make sure you’ve got some good records about address and how to get in touch with them. If you can’t otherwise force them out, and they don’t otherwise take a distribution, they might get lost,” he says. His firm encourages employers to confirm at the time of separation that the employment and/or plan records are up to date. If a participant is likely to move, it will be important to learn the new address. Terminating workers may also opt to receive disclosures electronically.

“They can opt to [send plan documents] to an email address,” he says, but “there are certain procedures that have to be followed under Department of Labor regulations [DOL] about using electronic communication. You need to make sure that you step through those guidelines.”

As they are still participants in the plan, even if not active or contributing ones, they still need to receive regular benefits statements, but those “might be going into a black hole,” Capwell says. In communication to terminated participants, he suggests requesting a confirmation of receipt—the individual can log onto a website or contact the plan administrator to verify that the contact information the sponsor has on file is current.

“There’s one issue out there that is getting some attention, and it’s going to be a big deal,” he says, pointing to the DOL’s pending fiduciary rule changes. Capwell feels the structure of the proposed rule could impact the availability of advice for terminated plan participants seeking guidance about what to do with money invested with a former employer. The rule would “make that a specific fiduciary activity, so that there could not be any self-dealing or conflicts of interest in those communications,” Capwell tells PLANADVISER. “That is a massive change that would be a complete reversal of existing positions on IRA solicitations.”

NEXT: Opting out 

“I don’t think there’s anything wrong with telling people about the fact that they have a right to a distribution, and they can do a direct rollover, and identifying for them what services are available,” Capwell says. As yet there are still few automated systems for rolling terminating workers’ balances to their new employer’s plan, so participants likely need the manual rollover system explained to them, and many will need help to initiate that process. An adviser can support that education process, and set up a system to help participants roll over their funds.

One point to watch out for, he warns, is that the sponsor not encourage people to take their money out, lest it trigger the “significant detriment” rule under Section 1.411(a)-11(c)(2)(i) of the income tax regulations. “If participants want to leave their money,” Capwell says, “they’re permitted to do so—until you can otherwise legally force it out.”

That rule states that an ex-employee’s consent to a distribution is not valid if his refusal would have a negative impact on his benefits. “You can’t impose any kind of ‘significant detriment’ on somebody, for instance by saying, ‘If you leave, you no longer can direct the investment of your account,’” he says. “That would be improper and impermissible under the significant detriment rules.”

Therefore, Capwell recommends not taking a “hammer” approach, but simply providing the relevant information: “You have this account balance and you can roll this over if you want.” Some people may honestly not know that they have left that money behind, he says. Communicate to ex-employees that they have an account with the plan, and use that opportunity to verify that the plan has the correct address on file. “That’s a way, too, to try to avoid the whole problem of lost participants.”