Former employees with a 401(k) balance

Your business can spend a lot of extra time and money over the years if former employees choose to keep their savings in your 401(k) plan. Employees come and go, but just because an employee is long gone, it doesn’t necessarily mean your administrative responsibilities to them are over.

There are many reasons why someone may continue participating in your company’s 401(k) plan after they’ve left. Maybe they retired, or haven’t found a new job. Some employees don’t know how to move their money to an Individual Retirement Account (IRA) or a new plan, and some might prefer your plan’s investment options. Others might simply forget about it altogether. It might make sense for some of those former employees to remain in your plan long-term, but not in every instance.

Take, for example, the case of a manufacturing company whose plan I recently reviewed. They were heading for a legally-required audit, which can cost upwards of $10,000, because the Employee Retirement Income Security Act (ERISA) requires that most plans with more than 100 participants undergo independent audits annually.1

Once a plan has 120 or more participants, ERISA requires independent audits annually.
This requirement remains in effect as long as the plan has 100 or more participants in subsequent years.

The company’s plan was sizable—they had 121 participants with a balance in their plan—but after we dug in, it turned out that 33 of those 121 participants were actually former employees who didn’t work for the company anymore. They’d since moved on, but had for whatever reason left their savings in the plan—and left the employer with the responsibility of conducting an expensive annual audit.

For this company and others in a similar situation, the next steps could be to review the participant roster, identify employees that should not be in the plan any longer, and work with them to move their savings to a new 401(k) or IRA. With these steps completed, the company’s new participant count would fall below 100, and they would be able to avoid the expensive audit.

This is just one example of how you may benefit from transitioning former employees out of your plan. As it turns out, there can be a lot of benefits for employers to evaluate and limit the number of former employees remaining in a 401(k), including:

  • Lower plan costs
  • Decreased employer fiduciary responsibilities
  • Avoiding an independent annual audit if you have less than 100 participants

So how do you know whether to keep a former employee in your plan or remove them? If you do want to move them, how does that work? And what happens when you decide to move an employee, but can’t get in touch with them? Let’s take a look at the responsibilities you have to your former employees and how you can move them out of your plan when that makes sense.

How do I determine whether to keep or remove a former employee from my plan?

As with most aspects of 401(k) management, the key here to determining who you should or should not remove is to develop and document a process you can use every time someone leaves your business. Here’s what the process typically looks like:

  1. Communication at time of termination: First, present an employee’s options for their 401(k) savings whenever they leave the company. This could be an exit interview or a packet that lays out their options for moving their savings, like receiving a cashout or rolling the money over to an IRA or a new 401(k). Also give them the paperwork they’d need to complete whichever of these actions they choose.
  2. Annual employee roster review: Once a year, review how many of your former employees have or have not taken an action to leave your plan. Compile a list of those former employees who still have money in your business’ 401(k), and take one of two steps depending on how much money they have:
  • For small balances: If a former employee has a balance of $5,000 or less, you can move them out of the plan yourself in what’s called a “force out.”
    • This does have to be specified in your plan, but nowadays most plans have this “force out” provision.
      • If yours doesn’t, add this provision to your plan and provide all the required notifications.
      • With this provision in place, your provider should be able to automatically remove anyone who meets this criteria on your behalf after a 30-day written notice.
      • When an employee is forced out, their savings are automatically placed into an IRA in their name. The new IRA provider should notify the employee about the transfer and how to access their new account.
    • For larger balances: When employees have more than $5,000 in their accounts, you aren’t allowed to force them out of your plan.
      • Instead, lean on your service providers to do an outreach campaign. Call, send letters, and encourage conversation around their remaining savings.
      • Maybe you’ll find that some employees are happy keeping things the way they are, and their money will stay in the plan.
      • Others, however, may want to do a 401(k) rollover and move their money from your plan to an IRA.

What if I can’t contact a former employee?

Now, once an employee has moved on, it’s not always easy for an employer to keep in touch. People change jobs, they move houses, they get new phone numbers. Eventually, mail will be returned as undeliverable, and the employee seems to have all but disappeared. What are your responsibilities when you simply can’t find a former employee? This is a confusing topic. In fact, it’s so confusing that three years ago, the Department of Labor (DOL) issued guidance on this to help employers understand their responsibilities.

According to the DOL, there are four steps you should take in order to try and locate a former employee:

  1. Use certified mail. With certified mail, you have some ability to ensure your communication is reaching the place it’s supposed to do. If it’s returned, that’s pretty good evidence that your former employee is no longer at their address.
  2. Check all your records for contact information. Your retirement plan’s records might be out of date, but you could have good contact information for your former employee somewhere else. Check any healthcare plans, other retirement plans, or HR records to see if there’s another way to contact them.
  3. Contact the employee’s designated beneficiary. When your former employee designated a beneficiary in your 401(k) plan, that person’s contact information was filed. Reach out to that person with a phone call or certified mail to see if they can put you in touch.
  4. Try free online search tools. If you still don’t get any results, the official guidance is to use free search tools out there online, or ones offered by your 401(k) service provider. The word “free” here is important because of where you go from here. If the free tool doesn’t pan out, you’ll have some decisions to make when it comes to continuing your search—or not.

If you complete all four of these steps and still cannot get in touch with your former employee, this is where you put on your “prudent person” hat to think about the best interest of that person in line with to your fiduciary responsibility. You can, if it makes sense, use some of that person’s remaining balance to conduct a paid search for them. Consider the account balance of your former employee relative to the cost of conducting a more advanced search—is that expense reasonable compared to how much money this employee still has in your plan?

Say the person in question has $6,000 left in your plan, and you’re able to complete a paid search for $60. If you do find that person, you’re bringing them 99% of their $6,000 balance, and they’re probably going to be very happy to hear from you. If, however, you have to spend something like 50% of their balance in order to conduct the search, they might not be thrilled to learn they lost half their savings.

Either way, if for these reasons you choose not to conduct a paid search, or you do and still can’t find the former employee, the next step is to document everything you did in trying to find this person. With that documentation in hand, you can move the assets out of your plan. The DOL wants you to do this in the best possible way to maintain the principal value of the assets and avoid a taxable event where the employee has to pay taxes and fees. Typically, that means you’ll move the assets to an IRA, where it would be invested in something called a “capital preservation” investment strategy designed not to rise or fall much, but remain steady. That way, if the employee ever does show up, they will hopefully find their assets looking very similar to how they left them.

The Importance of 401(k) Advisers for Employers and Employees

Examples like that of the business with 33 former employees in their plan only reinforce for me the importance of hiring a reliable adviser who is willing to do some of your plan’s administrative work on your behalf. Providers such as recordkeepers may not be ideal for the task since they charge service fees on a per-employee basis, so there’s little incentive for them to help you spot potential issues like this and lower your plan’s headcount. An adviser who charges a flat fee can help you review your plan regularly and keep it on track.

Making sure your employees have clear options for their savings in your plan isn’t just important for you as a business owner; it’s also of critical importance for your employees. In fact, cash outs that happen when an employee leaves a job are the number one drain on personal retirement savings.2 By establishing a clear procedure for “force outs” into IRAs and communicating with former employees who have higher balances, you can help them to avoid cashing out their savings prematurely and keep that money working for them.

Talk to your adviser about how they can help you develop a prudent process for removing former employees from your plan and helping employees keep as much of their retirement savings as possible.

 

1 https://www.dol.gov/agencies/ebsa/about-ebsa/about-us/erisa-advisory-council/employee-benefit-plan-auditing-and-financial-reporting-models

2 http://crr.bc.edu/briefs/401kira-holdings-in-2016-an-update-from-the-scf/

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