403(b) Curriculum Library

Terminated Participants: Out of Sight, Out of Mind – That is the Problem

With all of the merging, acquiring and partnering that continues to impact many industries, retirement plans are not always top of mind for organizations.  While a retirement plan review is often a part of the thorough due diligence process in any entity transaction, these reviews frequently occur towards the end of the process when there is less time to analyze the full extent of potential retirement plan issues.

As such, issues regarding terminated participants tend to receive even less scrutiny on a regular basis.  This is potentially problematic as the Department of Labor (DOL) has recently launched an initiative to audit retirement plans to confirm whether or not they have terminated, vested participants that might be owed plan benefits.  If such owed distributions “slip through the cracks,” it has the potential to run afoul of both DOL and Internal Revenue Service (IRS) requirements, exposing the plan to potential penalties and loss of tax qualification status.


When a participant terminates service with a plan sponsor, he/she has the choice whether or not to keep the accumulated retirement assets in the plan or to roll over the assets to an IRA or some other retirement plan.  The participant can also elect to withdraw the assets and pay taxes on the distribution. 

If the participant has less than $5,000 in the account, the plan sponsor can force the assets out of the plan (assuming such a provision is included in the plan document).  But for accounts over $5,000, the participant decides whether or not to keep the assets in the plan or move them somewhere else.

For a retired participant, the assets must begin to come out of the plan in the year following the year the participant turns age 70 ½. (Note: if a participant is over 70 ½ and still working, this distribution commencement may be delayed until termination of employment).  These Minimum Required Distributions (MRDs) that are part of Internal Revenue Code section 401(a)(9) begin the process of liquidating the participant’s account.  It also enables the IRS to begin collecting some of the deferred taxes on these assets.

If a participant fails to begin receiving MRDs, he/she faces a stiff penalty.  There is an excise tax of 50% of what the participant should have taken out for the distribution.  Because of this penalty, most participants follow the regulations when they are aware of them.  But many participants are unaware of the requirement, or potentially forget that they have reached the age when they must begin to take MRDs from their retirement plan assets.

Typically, the plan recordkeeper sends a notice to participants who are required to take a distribution.  This is the alert that reminds the participants that they are subject to this requirement and gets them to begin the distribution process.  However, not all participants keep their contact information up to date with the recordkeeper.  If they change home and/or email addresses, they may neglect to inform the plan recordkeeper about the change.  They are even less likely to notify their former employer.  This is how plan participants become “lost.”

Having lost participants is a very common condition for retirement plans.  Whenever we begin working with a new client, we always check to confirm if all participant contact information is up to date.  We have yet to encounter a situation where the recordkeeper did not have at least one “bounce-back” on the emailing of statements, or returns from the postal service for statements sent through the mail.  We always encounter some lost participants, whose contact information has not been kept current.

From the IRS’s perspective, this leads to a problem because the MRDs for these participants may not begin on time, and thus, the IRS will not collect taxes in the time frame that it should.  From the DOL’s perspective, this is also a problem because the vested benefits that these participants have earned are not being paid in the time frame expected.  When left unchecked, it is possible that the benefits do not get paid at all and remain unclaimed in the plan.

This brings us back to the recent audit initiative.  The DOL has been examining plans to confirm that the plan sponsor has the procedures in place to locate plan participants and to pay them their vested plan benefits when required.  Many retirement plans do not have the written description in place about how the sponsor will work to locate lost participants, the time frames and responsibilities.  And many of those that do have such procedures in place are not completing the process on the regular timely basis specified in the plan document.

Plan sponsors, particularly organizations that are in the midst of, or have just completed, merger/acquisition transactions, should review their plan document to confirm whether or not there are written procedures in place to locate terminated vested participants who have become lost.  If they have not done so in a while, if ever, they should work with their recordkeeper to determine if they have any lost participants, and then follow the process to attempt to locate those individuals.  Once they have implemented the process to obtain up-to-date contact information for lost participants, it is important to establish a process to ensure that such a review will be completed on whatever regularly scheduled timeframe is outlined in the plan documents.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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