In today’s environment, employees change jobs more frequently and with the baby boomers hitting retirement age, it’s common for 401(k) plans to have a significant number of orphan accounts. Plan administrators may need to determine a strategy as to how to handle these accounts. In order to effectively implement a strategy, the following factors must be considered: (1) how does your plan charge administrative fees, and (2) the value of these orphan accounts.
The accounts of 401(k) plan participants who are no longer employees are known as orphan accounts. In today’s environment, it is not uncommon for 10% of a plan’s participant census to consist of terminated employees, and, depending on the employer, the percentage could be much larger.
There are two trends of thought as to the effect of orphan accounts on administrative costs. One position is, the bigger the asset pool, the lower the per-capita charges. The possible upside is that all participants are benefiting from lower administrative and asset management charges because they’re based on a scale according to total plan assets, which benefit from the inclusion of these orphan accounts.
However, one must analyze how these fees are based. Do these fees have brackets, and would the elimination or lessening of these orphan accounts push your plan into a lower fee bracket? Fees charged against participant accounts based on the size of their accounts could effectively be penalizing those participants for incremental administrative costs incurred on behalf of people no longer working for the company.
Consideration should also be given as to: (1) if the employer is subsidizing any of the plan’s administrative charges, doing so for former employees might not be considered an effective use of your organization’s dollars, and (2) the indirect cost of added staff time devoted to administrative or compliance tasks associated with those accounts.
Whether a third-party administrator is administering the plan or the company does it internally, (1) former employees need to receive 404(a)(5) fee disclosure forms, along with other routine disclosure documents, and (2) each year you need to regularly update IRS Form 8955-SSA, listing terminated participants. Be aware of the time spent and the costs!
The First Step Is to Formalize a Policy
Here are some possible options:
(1) You might decide to focus on former employees who left the company before retirement, instead of retirees. This may just be a prioritization issue, however, because you can’t discriminate against any set of participants.
(2) Set a dollar threshold on the size of the orphan account. Under ERISA, you can distribute accounts with balances up to $1,000 directly to the former participant without obtaining their permission, if your plan document permits it. And for accounts with balances up to $5,000, you can, again without obtaining the former participant’s permission, transfer the funds to an IRA that you establish on his or her behalf.
If your plan also has larger orphan accounts, you can contact the former employees (assuming you can track them down) and remind them of the option to roll their funds into an IRA or a new employer’s plan, or keep them in the current plan.
Try to stay in contact with former employees, thereby avoiding the possibility that those funds could be taken over by your state.
Always remember that plan sponsors have a fiduciary responsibility to all plan participants (active employees, former employees, beneficiaries or retirees). Be sure to weigh the pros and cons of your policy from the perspectives of these groups before deciding which approach to take. In the end, it may be better to lower your risk by outsourcing the process to another custodian service that specializes in this activity.