Uncashed Pension Checks: More Than Just An Accounting Problem
Last year, CPA James Haubrock made a presentation to the ERISA Advisory Council on behalf of the American Institute of Certified Public Accountants download PDF. In it, he discussed a number of accounting and auditing issues associated with unclaimed benefits and uncashed checks for lost retirement plan participants.
Haubrock made some excellent points to the council, and raised some serious issues the retirement plan industry has consistently swept under the rug since the enactment of ERISA. However, as an auditor rather than a plan administrator or record keeper, he did not address the tax, legal and fiduciary responsibilities surrounding lost participants and uncashed checks. As one who has dealt with these problems for decades, I would like to offer a different perspective on one of the biggest challenges facing the retirement plan industry.
The failure to address the potential tax implications of uncashed checks represents part of the problem for many in our industry. For example, although Haubrock accurately describes the Department of Labor (DOL) Safe Harbor process in dealing with non-responsive/missing participants and their unclaimed benefits, he misses the mark when discussing what to do with account balances that exceed $5,000 in a terminated plan.
Prior to enactment of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), there was no official way to transfer an account balance to what we now call a Default/Auto Rollover IRA. As a result, a retirement plan could not be closed until all the money in the plan had been distributed. With the passage of EGTRRA, a terminating plan that can’t find some participant with an account balance in excess of $5,000 can now transfer those funds into such an IRA. This is the only time a plan account worth more than $5,000 can be deposited into an IRA. Doing so allows the plan sponsor to legally terminate the plan and distribute all of the plan assets, regardless of the participant’s balance.
As Haubrock accurately notes, the DOL provides no definitive guidance on when a distributed benefit ceases to be a plan asset, or how plans should account for the plan benefits and related assets for lost participants. Currently, the DOL maintains that distributed benefits are still plan assets even if they have been taxed. However, absent further guidance, this position adds to the confusion and leads to misguided conclusions.
The silence of the IRS on this matter has been equally disturbing, especially considering it is the IRS who receives the funds when taxes are withheld from benefit payments. In all likelihood, those funds will never be refunded because the lost participants probably won’t file a tax return. If lost participants don’t file within three years, they lose the funds forever.
In my opinion, failing to restore withheld taxes and not paying interest on non-invested lost participant funds creates a significant breach of fiduciary liability to the plan sponsor and the benefit payment processor. Restoring withheld taxes is not a complex problem; it merely requires an adjustment to the 945 form. And crossing over into the next calendar year, which will happen as we get closer to year’s end, requires the institution or processor to file an application to recapture the funds. However, neither of these is difficult or time-consuming, which begs the question: why aren’t more institutions doing it?
Haubrock also suggests that a plan sponsor’s inability to locate lost participants can impair effective plan administration. In reality, it can actually offer several advantages. Let’s use a 401(k) plan as an example. When a participant is lost, the plan sponsor can’t communicate changes in investments, fees, and other important plan information. Rather than impairing plan administration, this provides an incentive to remove account balances with less than $5,000 from the plan. Doing so can reduce plan management costs, and more importantly, reduce the fiduciary liability, which intensifies with the inability to communicate with former employees.
As Haubrock points out, plan sponsors that have their retirement plan custodied or trusteed by a bank insurance company, broker or mutual fund may never know of the existence of uncashed checks – mainly because those institutions often have no mechanism for automatically reporting such occurrences. A small and hopefully growing number of institutions are making an effort to improve in this area. However, lack of knowledge does not exempt plan sponsors from ensuring that all benefit payments are properly executed.
This brings us to the role of the gatekeeper, which, in my opinion, should be the TPA. After all, who knows more about which plan participants are getting paid than the plan administrator? Every three months, the TPA should prepare a letter for the plan sponsor that lists all the checks issued for the quarter and instructs the institution to verify which checks have cleared and which have not. Upon receiving this verification, the TPA should determine which checks have gone uncashed and then conduct an immediate search to see if the participant is missing. The TPA can conduct the search using internet search engines or outsource the service to a firm, such as PenChecks, that specializes in performing extensive plan participant searches.
Even if the participant can’t be located, the institution still needs to compute the interest owed on the account. The institution should then credit the participant with the interest, restore the taxes, and either return the funds back to the plan or establish a Default /Auto Rollover. The institution may not welcome this responsibility, but if enough plan sponsors took their fiduciary responsibility more seriously, financial institutions would quickly come up with solutions.
The TPA Perspective
Haubrock’s presentation was on target in many areas, including his description of the types of accounts used to make benefit payments. He also rightfully pointed out that plan sponsors may not know of the existence of stale-dated or uncashed checks until terminating the plan (which is not an excuse for avoiding their fiduciary responsibility). However, I take issue with several of his key points, and would like to present an alternative point of view.
- The use of omnibus accounts. Haubrock’s claim that trustees using an omnibus account is equivalent to paying out a participant is not accurate. In reality, the money resides in a “holding” account that typically contains funds belonging to many individual account holders. As long as funds are held within the plan, they will require an accounting and paying of interest of some kind, but they cannot be considered as a distribution.
- Transferring plan assets to payroll. Haubrock also stated that some plan sponsors transfer plan assets to their payroll to pay benefits, making it hard to determine the reason for the payment. In almost 50 years as a benefits consultant and TPA, I have never seen that practice, although I can believe it has occurred. Furthermore, such a practice raises a number of issues about returning plan assets back to the plan sponsor, including whether it might be considered a prohibited transaction.
- Terminating plans. Haubrock stated that plan sponsors who can’t locate lost participants and reissue checks are unable to terminate their plans, which is not correct. By establishing a Default IRA for every missing participant, plan sponsors can proceed with closing their plans.
- Forfeiture accounts. Haubrock also discussed how some institutions and plan sponsors are using a forfeiture account as the depository for unclaimed funds when the plan permits such an option. However, if you do not restore the taxes, under what regulation can you deposit non-qualified money into the plan without subjecting the plan to disqualification? Instead, assuming you have restored the taxes, why not restore the participant account? That way, the institution credits the account with the correct amount of interest for the uncashed check. This guarantees proper accounting of the participant’s account and eliminates the risk of the funds disappearing while in the forfeiture account.
- Ability to locate plan records. Haubrock suggested that if a check remains uncashed for several years, plan sponsors may not be able to locate the records of how the participant’s account was invested, preventing them from restoring the account. Considering that today’s plans all maintain a Qualified Deferred Investment Account, which holds assets for plan participants who have failed to decide on where to invest their money, this argument does not hold up.
- DOL FAB 2004-02 regulations. According to Haubrock, the DOL FAB 2004-02 allows plan fiduciaries to consider transferring many participants account balances to state unclaimed property funds. However, FAB clearly states that this option can be used only when other options are not available. Haubrock also stated that situations may arise where the plan account cannot use this safe harbor, and the plan cannot be legally terminated when the participant account balance exceeds $5,000. Again, this is not correct.
- Materiality. When discussing how auditors are guided by “reasonable assurance” and “materiality,” Haubrock stated that uncashed checks are not considered material. I disagree. Back in the 1950s, 60s and early 70s, plan auditors made a point to audit the movement of money out of the plan to ensure the funds where properly cleared. In fact, when I worked at Wells Fargo Bank, companies like MJB Coffee, Bechtel Corp., Crown Zellerback, Levi Strauss and others would regularly hire big eight firms to perform their audits. Two weeks after an audit was completed, I would receive a letter listing all uncashed checks by name and amount. The letter also included the amount of interest the bank owed each participant, with instructions to return the funds to the plan after crediting the interest. Wells Fargo never once challenged or objected to the paying of interest.
What happened after the enactment of ERISA to create such uncertainty around uncashed checks? Certainly, the banks did not stop understanding their fiduciary responsibility. I believe that after the passage of ERISA, the qualified plan market, and especially 401(k) plans, grew so rapidly in size and scope that many details began falling through the cracks. Only now are we beginning to understand the full scope of this problem – and to wrestle with creating effective solutions.
In his concluding comments, Haubrock called for plan administrators to establish internal controls to identify and monitor uncashed checks so they get handled in accordance with plan document and established administration procedures. He also suggested five recommendations the DOL should implement, several of which support my comments about TPAs acting as the gatekeeper.
While I have expressed my disagreements with some of Haubrock’s points, I appreciate his efforts in furthering the dialog around this important issue and his thoughtful recommendations for improving our ability to manage it. I believe that the more auditors, plan sponsors, record keepers and financial institutions work together, the better we can serve our clients while upholding our fiduciary responsibilities.
Peter E. Preovolos is a founder and CEO of PenChecks, Inc., the largest independent provider of outsourced benefit distribution services and default/missing participant IRAs in the country. An acknowledged expert on un-cashed retirement plan checks, Preovolos has worked for decades to raise awareness of this important issue, and has developed a number of innovative solutions for managing these unclaimed assets.