A new report by the Government Accountability Office calls on federal regulators to clarity the rules regarding the transfers of unclaimed savings from employer-based 401(k) plans to the states.
In “Federal Action Needed to Clarify Tax Treatment of Unclaimed 401(k) Plan Savings Transferred to States,” the GAO examines how much in retirement savings is transferred to states as unclaimed property, what steps the IRS and DOL have taken to oversee these transfers and what improvements are needed. The report was requested by Sen. Ron Wyden (D-OR), the ranking member of the Senate Finance Committee.
Individuals changing jobs throughout their careers can lead to lost and unclaimed savings, resulting in millions of dollars in retirement savings being transferred to states as unclaimed property, only some of which is later claimed by owners. GAO notes that, of the 22 states responding to its survey, 17 states provided data indicating that $35 million in unclaimed retirement savings was transferred to them from employer plans and individual retirement accounts (IRAs) in 2016.
The agency acknowledges that may not seem like a lot in the total DC market, but it contends that even small amounts can grow substantially over time. For example, it notes that previous work by GAO shows that, with a reasonable interest rate and other assumptions, $2,643 in retirement savings for a younger worker can grow to $85,857 by the time they reach retirement age due to compound interest.
Tax Treatment and Rollovers
To better ensure that federal taxes are properly applied and better protect the retirement security of individuals affected by these transfers, the GAO offers three recommendations, including that the IRS should clarify whether transfers of unclaimed savings from 401(k) plans to states constitute reportable and taxable distributions.
The IRS also should consider adding retirement savings transferred to states from terminating DC plans to the list of permitted reasons for rolling over savings after the 60-day rollover period, according to the agency.
The report notes that the IRS has provided guidance on the tax reporting and withholding requirements for transfers from IRAs, but it has not done so for 401(k) plans. In addition, while the IRS and Department of Labor have issued guidance on transferring retirement savings to states, the IRS has not specifically clarified that the retirement savings that owners claim from states can be rolled over into other tax-deferred retirement accounts.
“Without IRS clarification on whether transfers should be reported to IRS as distributions and when they should be subject to federal income tax withholding, not all plan service providers can be certain about the appropriate actions to take,” GAO explains. This can affect not only the collection of federal income tax withholding, but also individuals’ retirement security, the agency notes.
“Federal law seeks to protect the interests of participants in retirement plans. However, without including savings claimed from states among the reasons to allow a rollover after more than 60 days, IRS may be missing an opportunity to allow individuals an avenue to retain their retirement savings in a tax-deferred vehicle after a plan termination,” GAO says.
The IRS agreed with the GAO’s recommendations and noted that it will work with the Department of the Treasury to address them. The IRS, however, did not specify what those actions might be.
Uncashed Checks
The GAO further recommends that the Labor Secretary specify the circumstances, if any, under which uncashed distribution checks from active plans can be transferred to the states.
The DOL apparently has not specified whether uncashed 401(k) plan distribution checks can be transferred to the states as unclaimed property under ERISA. Clarification would help both states and retirement plan service providers better navigate the available options for managing these checks, the report notes, while adding that clear options could result in better outcomes for the account owners.
In its response, the DOL said that it neither agreed nor disagreed with GAO’s recommendation. However, DOL stated it plans to continue to evaluate whether there are circumstances in which the transfer of uncashed distribution checks from an ongoing plan to the states advances the goal of reuniting missing participants with their savings, consistent with GAO’s recommendation.
Given the recent attention and lack of formal guidance addressing missing participants for ongoing DC plans, there have been increasing calls for the government to formally address how far plan sponsors need to go to find missing participants. In addition, the PBGC expanded its missing participants program in 2017 to include terminated 401(k) and other plans in an effort to make it easier for people to locate their retirement benefits after their plan terminates.
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