It has become common for 401(k) plans to include a significant number of orphan accounts due to employees changing jobs more frequently and much of the workforce hitting the retirement age. If your plan has a lot of them, it might be time to consider actively pursuing 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 is not unusual for about 10% of a plan’s participant census to consist of terminated employees.
When this happens, it is important you consider the administrative costs. An upside of orphan accounts could mean there is a bigger asset pool, which incurs lower per-capita charges. If the collective value of those former employees’ accounts is significant, the possible benefit is that all participants are benefiting from lower administrative and asset management charges because they are based on a scale according to total plan assets.
However, there could be a downside. Suppose those orphan accounts do not 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. In addition to hard dollar expenses, you will want to consider the indirect cost of added staff time devoted to administrative or compliance tasks associated with those accounts.
There are also several administrative tasks involved. For one, you will need to be sure those former employees receive 404(a)(5) fee disclosure forms, along with other routine disclosure documents. You will also need to regularly update IRS Form 8955-SSA, listing terminated participants. Even if you have a third-party administrator performing those tasks, you are still paying for it.
Design a policy
If your plan consists of many orphan accounts, what should be done? The first step is to formalize 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 cannot discriminate against any set of participants. (See “Fiduciary Responsibilities.”)
Other policy decisions include whether or not 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. For accounts with balances up to $5,000, you can transfer the funds to an IRA that you establish on an employee’s behalf without obtaining their permission. These options can be beneficial to your plan.
For larger orphan accounts, you do not have these options. However, you can 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.
The former employee may prefer to move the funds to an IRA to gain more control over how to invest those funds. However, others may leave their accounts with your plan because they like the way it is invested.
Keep in mind that if you completely lose track of former employees, there is the possibility those funds can be taken over by your state.
Take these steps now
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.
Sidebar: Fiduciary responsibilities
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 are active employees, former employees, 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 more information on what to do with orphaned 401(k) accounts, contact Stephanie Zaleski at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Employee Benefit Plans Services.