With employees changing jobs more frequently than they once did and Baby Boomers hitting retirement age, it’s common for 401(k) plans to include a significant number of orphan accounts. If your plan has a lot of them, it might be time to think about whether it’s time to actively pursue these accounts. The answer depends in part on how your plan charges administrative fees and the value of these orphan accounts.
Orphan accounts are accounts of 401(k) plan participants who are no longer employees. It’s 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.
This demands that you consider the administrative costs. On the one hand, the bigger the asset pool, the lower the per-capita charges. If the collective value of those former employees’ accounts is significant, 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.
On the other hand, suppose those orphan accounts don’t add up to enough dollars to 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.
Similarly, if you, as the employer, are 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 in addition to hard dollar expenses, you’ll want to consider the indirect cost of added staff time devoted to administrative or compliance tasks associated with those accounts.
What kind of administrative tasks? For one, you’ll need to be sure those former employees receive 404(a)(5) fee disclosure forms, along with other routine disclosure documents. You’ll also need to regularly update IRS Form 8955-SSA, listing terminated participants. Even if you have a third-party administrator performing those tasks, you’re still paying for it.
Make a policy
So, if orphan accounts are needlessly driving up plan costs, what can you do about it? The first step is formalizing a policy. For example, 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. (See “Orphan 401(k) accounts require fiduciary juggling act.”)
Other policy decisions include whether to 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.
For larger orphan accounts, you don’t have that option. You can, however, 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.
They may prefer to move the funds to an IRA to gain more control over how to invest those funds. But other former employees may leave their accounts with your plan because they like the way it’s invested.
Keep in mind that, if you completely lose track of former employees, there’s the possibility those funds can be taken over by your state.
Orphan accounts could be helping or hurting your administrative costs. Find out which it is, and then review your options with your employee benefits specialist to determine what’s best for your plan.
Orphan 401(k) accounts require fiduciary juggling act
Plan sponsors have a fiduciary responsibility to all plan participants. However, the process of determining what to do with orphan accounts requires a delicate balancing act on the part of plan sponsors.
For example, if former employees feel that they were strong-armed into making a rollover, and wind up with an IRA that has higher fees, you could face accusations of violating your fiduciary duty to those former participants. One way to lower that risk is to outsource the process to another custodian service that specializes in this activity.
In the final analysis, your fiduciary duty is to all your plan participants, whether they’re active employees, former employees who have moved on to other jobs, 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.
For a no-obligation discussion on the possible impact and steps you should take now, contact Meresa Morgan, our Audit Shareholder with significant experience in this area.