Workforce reductions and employees leaving for other opportunities have left some employers with numerous low-balance retirement plan accounts owned by their former employees. These small account balances can be expensive to maintain and can be time-consuming to administer.
The presence of numerous low-balance retirement plan accounts raises several questions for plan sponsors as to the best way to handle these accounts. What options are available to plan sponsors and what, if any, are the compliance risks involved in exercising some of these options? What follows is a brief overview of the options that may be available to plan sponsors.
Option 1: The small account cashout
Under federal law, plans can provide that, if a former employee has not made an affirmative election to receive a distribution of his or her account assets or to roll those assets over to an individual retirement account (IRA) or to another employer’s plan, the plan can distribute the account—as long as its balance does not exceed $7,000.1 For accounts that are valued at $1,000 or less, the plan can send the former employee a check for the balance, less any income tax (and penalties if the employee is under age 59½) owed. Distributions of more than $1,000 must be directly transferred to an IRA established for the former employee. Accounts valued at less than $1,000 may be distributed directly to the participant or may also be rolled over for administrative convenience.
Plans sponsors only have to include the value of the ex-employee’s non-forfeitable accrued benefit. In other words, plan sponsors do not have to count the non-vested portion if the departed employee was not fully vested in any portion of the account at the time he or she ended employment.
Plan sponsors need to pay particular attention to the issue of rollovers. A plan may provide that any amounts that a former employee rolled over from another employer’s plan (plus earnings on those rolled-over assets) are to be disregarded when it comes to determining the former employee’s non-forfeitable accrued benefit for small account distributions.
Fiduciary duties involved in rolling over a small account
Plan sponsors must meet the following requirements in order to fulfill their fiduciary duties:
– The rollover must be a direct transfer to an IRA established in the name of the former employee.
– The IRA provider must be a state- or federally regulated financial institution, a mutual fund company or an insurance company whose products are protected by a state guaranty association.
– The plan sponsor must have a written agreement with the IRA provider that outlines appropriate account investments and fees.
– The IRA provider cannot charge higher fees than typically charged for a comparable rollover IRA.
– The investments selected by the plan sponsor for the IRA must be intended to preserve principal and provide a reasonable rate of return and liquidity. Money market mutual funds, certificates of deposit, stable-value products- and interest-bearing savings accounts are examples of appropriate investments.
Pre-Cash-Out disclosures
Prior to cashing out a small balance account, plan sponsors must notify the former employee in writing, either separately or as part of the rollover notice, that unless the employee makes an affirmative election to receive a distribution of the account’s assets, or roll them over to another account, the distribution will be paid to an IRA. The notice requirement will generally be considered satisfied once the plan sponsor sends the notice to the employee’s last known mailing address. In addition, plan sponsors must include a description of the plan’s automatic rollover provisions for mandatory distributions in the plan’s summary plan description (SPD) or summary of material modifications (SMM).
Option 2: Retaining small balances
Some plans may consider retaining small balances indefinitely. Others may consider retaining the small plan balances and allowing the balance to be eroded over time by administrative fees. However, these approaches present a legal risk. Under ERISA, a plan administrator is obligated to operate the plan and make discretionary decisions in a prudent manner and in exclusive benefit of the plan participants. Plan sponsors that do not place the interest of the participants first run the risk of breaching their fiduciary duties under ERISA.
Plan sponsor best practices
When an employee gives (or is given) notice to leave a company, the employer should immediately provide the employee with the paperwork and forms necessary to request a withdrawal. Participants need to be notified of their rollover rights and tax implications of withdrawals. The plan sponsor should put procedures in place that make processing withdrawals easy. If, for whatever reason, a departing employee does not request a withdrawal, the sponsor should send distribution reminders to this employee every year. Plan sponsors should be aware that while they want to encourage departing employees to move their money as soon as they terminate employment, they cannot force employees to withdraw the money until retirement age if the account is greater than $7,000.
In addition, plan sponsors should be diligent about maintaining current addresses for terminated/former employees who opt to leave their money in the plan.
Your UBS Advisor can be a valuable resource when it comes to explaining your options as a plan sponsor when it comes to handling low balance retirement plan accounts owned by former employees. Make sure to also contact your tax and/or legal advisor as UBS does not provide legal and tax advice.
Recent research from the Investment Company Institute (ICI)2 finds that the long-term financial outlook for younger generations is more promising than had been previously assumed. Despite managing what is for many substantial student loan debt while attempting to get a head start on careers and families, researchers at ICI say that this demographic have made “more progress in retirement savings than prior generations had at the same stage of life.”
The research specifically noted that both retirement account ownership and asset accumulation among younger US households have trended higher in recent decades.
Figure 1. Percentage of Households Aged 18 to 25 with a Retirement Account
|
| 1989 | 1989 | 2022 | 2022 |
|---|---|---|---|---|---|
| DB Plan, DC Plan or IRA | 1989 | 15% | 2022 | 34% |
| DC Plan or IRA | 1989 | 10% | 2022 | 30% |
| DC Plan | 1989 | 7% | 2022 | 24% |
Figure 2. Median DC Plan Assets, in 2022 Dollars, for Households with DC Plans
|
| 1989 | 1989 | 2022 | 2022 |
|---|---|---|---|---|---|
| Households Aged 18 to 25 | 1989 | $1,729 | 2022 | $5,000 |
| Households Aged 26 to 41 | 1989 | $11,528 | 2022 | $26,000 |
ICI’s researchers attribute the high rates of account ownership and asset accumulation of Gen Z individuals to the prevalence of defined contribution (DC) plans, which usually offer employer contributions, and have overtaken defined benefit plans as the primary type of private-sector workplace retirement plan. The data shows that thepercentage of Gen Z households with DC plan accounts is more than three times that of similar-age Gen X households in 1989.
The researchers also cite automatic enrollment as playing a role in boosting DC retirement account ownership. In fact, tabulations from the ICI Annual Mutual Fund Shareholder Tracking Survey cited by the study’s authors found that more than half of DC-owning households younger than 35 in 2023 reported they had been automatically enrolled.
In addition, the ICI researchers noted that Gen Z households prioritize retirement saving more often than similar-age Gen Z households in 1989. Based on ICI tabulations of the Federal Reserve Board’s Survey of Consumer Finances, nine percent of households aged 18 to 25 in 2022 cited retirement as the primary reason for family saving compared to two percent of similar-age households in 1989.
The critical role of DC plans
Other research conducted by ICI3 underscores how critically important DC plans are to young Americans’ financial future. The research found that more than half of DC account owners younger than 35 say that they probably would not save for retirement were it not for their workplace plan. More than 75% of the same cohort said that the tax treatment of their retirement plans is a big incentive to contribute. And 84% of DC account owners under age 35 agreed that their plan helps them think about the long term, not just their current needs.
Plan sponsors who find that their employee participation and/or contribution rates are lower than they would like (not just for Gen Z employees but for all other employee demographic groups) may want to revisit and reevaluate elements of their retirement plans. It may require broader investment choices, a bigger employee match, automatic features and an enhanced financial wellness education program to help move the needle.
Plan sponsors have significant reporting and disclosure requirements under ERISA. Additionally, ERISA and Department of Labor regulations require plan sponsors to retain broad categories of records related to meeting those responsibilities. This means that plan sponsors should understand the applicable rules and put into place a record retention policy governing how they periodically review, update, preserve and discard documents related to plan administration.
Why retaining plan records is important
A workable, comprehensive record retention process improves plan efficiency and allows plan sponsors to quickly respond to employee documentation requests or changes. An effective policy also ensures that all documents will be easily available in case of a plan audit. During an audit, plan sponsors must generally provide voluminous amounts of documentation that can help make the case that the plan has been managed in a responsible and prudent manner and is in compliance with all applicable regulations.
Who is responsible?
It is the responsibility of the plan administrator (the employer) to retain records of plan documents and participant notifications, as well as contribution, benefit and testing information. While plan sponsors typically employ outside service providers to provide various reports and prepare the plan’s Form 5500 filing, it is the plan administrator that bears ultimate responsibility for retaining the records required to support the reports, filings and benefit determinations. Best practices should encourage plan sponsors to maintain easy and quick access to all plan-related documents and ensure that backup copies are maintained in a secure site.
The Six-Year requirement
Under ERISA Section 107,4 any individual required to file any report must maintain, generally, for a period of “not less than six years” after the document is filed, a copy of such report. It also requires that all records supporting information detailed in a plan’s Form 5500 and other reports and disclosures must also be retained.
Such supporting documents include any financial reports, trustees’ reports, journals, ledgers, certified audits, investment analyses, balance sheets, income and expense statements, corporate and partnership income tax returns, and documentation supporting the trust’s ownership of the plan’s assets. Also included is evidence of the plan’s fidelity bond as well as copies of nondiscrimination and coverage test results.
In addition, any documents that support any decisions made by the plan administrator must be retained for this six-year period, including all copies of all corporate/partnership actions and administrative committee actions relating to the plan.
Record Retention—Indefinite period
A plan administrator is required under ERISA Section 2095 to “maintain records with respect to each of [its] employees sufficient to determine the benefits due or which may become due to such employees.” Since the statute does not specify a time limit, plan administrators must retain such records indefinitely. Records necessary to determine benefits and eligibility for plan participation would include any related to dates of service, eligibility, vesting, contributions and more.
Records that plan administrators must retain include the following:
– The original signed and dated plan document
– All original signed and dated amendments to the plan
– Communications and plan documents that are distributed to plan participants, including summary plan descriptions (SPDs), summaries of material modifications (SMMs) and any other descriptions of the plan
– The determination, advisory or opinion letter for the plan
– Copies of Form 5500
– Payroll records that were used to determine eligibility and contributions, including information that can support any exclusions from participation
– Proof of the plan’s fidelity bond
– Documents that show the trust’s ownership of the plan’s assets
– Documents that relate to plan loans, withdrawals and distributions
– Results from nondiscrimination and coverage tests
– Personal employee information—Social Security number, date of birth, marital/family status
– Information related to participant’s employment history, including hire, termination, and rehire dates (if applicable) and details on termination
– Election forms for deferral amount, investment directions, beneficiary designations and distribution requests
– List of contribution and distribution transactions
– Owner and officer history and familial relationships
– Spousal consents and waivers (notarized)
Electronic documentation
Records can generally be maintained electronically as long as the retention system meets ERISA requirements. The retention process must generally:
– Permit easy conversion to legible and readable paper copies to satisfy ERISA’s reporting and disclosure requirements.
– Keep records in reasonable order and in a safe and accessible space that permits indexing, retaining, retrieving and reproducing.
– Have reasonable controls that can ensure the accuracy, reliability and authenticity of the records.
– Create and implement adequate records management practices,6 including, but not limited to, following procedures for labeling of electronic records and saving backup copies.
Paper records may generally be disposed of any time after being transferred to a compliant electronic record system. However, the retention of an original paper record is required if the electronic record would not constitute a duplicate or substitute record under the terms of the plan and applicable federal or state law.7
Plan sponsors may wish to review their plan’s administrative procedures regarding their record retention policies to ensure they meet ERISA’s requirements.
3 ICI Research Report, February 2024, American Views on Defined Contribution Plan Saving, 2023, ici.org/system/files/2024-02/24-ppr-dc-plan-saving. pdf.
