PBGC Proposes Broadened Program for Preserving Benefits of Missing Participants in Terminated Plans, Including Individual Account Plans

Following up on a legislative mandate included in the Pension Protection Act of 2006, the Pension Benefit Guaranty Corporation (PBGC) has published proposed regulations that would enable it to act as a custodian for the benefits of participants who cannot be located when their plans terminate.  This program already exists for terminating PBGC-insured single employer plans.  The proposal would revise it somewhat and expand it to include: 

• ERISA-covered individual account (defined contribution) plans, including section 403(b) tax-deferred custodial accounts, but not including 403(b) annuity contracts, governmental plans, or church plans that have not elected ERISA coverage
• Defined benefit plans of small professional employers that are exempt from PBGC insurance coverage
• PBGC-insured multiemployer defined benefit plans

The proposal also announces the PBGC’s plan to create “a new unified pension search database” that will “include information about missing participants and their benefits and a directory through which members of the public could easily query the database . . . to determine whether it contained information about benefits being held for them.”

Participation in the revised and expanded program would be mandatory for PBGC-insured single employer plans (as it already is) and multiemployer plans.  It would be voluntary for individual account plans and small professional employer defined benefit plans.  Participating plans (both voluntary and mandatory) will, for the first time, be charged a user fee to help defray the administrative cost of the programs.  The fee will be set initially at $35 per participant for benefits valued at $250 or greater (no fee for smaller benefits), payable at the time when assets are transferred under the program.  Fees may be deducted from the amount transferred and thus will be borne by participants.  There will be no maintenance fees after the initial payment.

The missing participants program comes into play only when plans terminate and close out by distributing all of their assets in satisfaction of all of their benefit liabilities.  It would not apply, for instance, to a terminated multiemployer plan that continued to operate as a wasting trust.

One quirk that may not be intuitively obvious is the meaning of “missing.”  A participant in an individual account plan will be regarded as “missing” if he fails to elect between directly rolling over his account balance to another plan or an IRA and receiving it as a distribution.  The same definition will apply to defined benefit plan benefits valued at $5,000 or less that are subject to mandatory cash out under the terms of the plan.  Defined benefit plan participants with larger benefits will be “missing” only if the plan administrator in fact does not know how to get in touch with them.

Individual Account Plans.  By far, the most significant part of the proposal is the extension of the missing participant program to individual account plans.  At present, a terminating plan has no good alternatives for dealing with participants and other distributees who cannot be located.  The Department of Labor (DOL) has weighed in on what plan administrators should do in order to satisfy their fiduciary obligations under ERISA.  See Field Assistance Bulletin 2014-01 (Aug. 14, 2014).

• Mailing a check to the individual’s last known address is unacceptable, as the likelihood that the distribution will reach its intended recipient is low.  Furthermore, uncleared checks arguably remain plan assets, and the termination is incomplete so long as they remain outstanding.  It thus is impossible to comply with the IRS’s requirement that a terminating individual account plan should distribute all of its assets within 12 months, except in highly unusual circumstances.  A plan that does not meet that deadline is obligated to continue filing Form 5500s and complying with qualification requirements.  See Rev. Rul. 89-87, 1987-2 C.B. 81.
• The DOL’s preferred course of action is for the plan administrator to set up an individual retirement account (IRA) in the missing participant’s name and transfer the account balance into the account as a direct rollover.  In that way, the funds remain in a tax-deferred vehicle, and there are no immediate tax consequences to the intended recipient.  There are, however, drawbacks.  The absence of a tax event eliminates any chance that the IRS will discover a discrepancy in the taxpayer’s reported income and alert him to the IRA’s existence, and an undiscovered IRA is subject to eventual escheat under state unclaimed property laws.
• Whatever the merits of the IRA solution, it is not always practicable.  Particularly for small balances, maintenance fees may be so high, and the earnings generated by a conservative default investment option so low, that the benefit is considerably reduced before it escheats.  DOL guidance offers two fallback options:  transferring the funds to a federally insured, interest-bearing bank account in the participant’s name or to the unclaimed property office of his state of residence.  In either case, the plan would have to issue a Form 1099-R reporting taxable income, increasing the chance that the distributee will learn about the benefit via an IRS inquiry concerning his failure to report it.  Another possibility for discovery lies in state databases of unclaimed property, now conveniently searchable on-line.

As proposed, the PBGC’s new program will offer two additional options.  One is very simple:  the plan sponsor will inform the PBGC of the identity of some or all of the plan’s missing participants, with information about what has been done with their accounts, and the PBGC will add the names to its unified database.

The other option is to transfer the accounts to the PBGC, which will credit interest at the federal mid-term rate and distribute the balance when and if a proper recipient shows up.  As noted above, a one-time fee (which may be deducted from the transferred balance) will be charged for this service.  To avoid “adverse selection” (the transfer of only minuscule account balances exempt from the fee), all missing participants’ accounts, if any, must be transferred.  By contrast, no “all or nothing” rule will apply to plans that merely send the PBGC information about missing participants.

When (and if) the time comes to distribute transferred account balances, the PBGC will follow rules similar to those that it uses for benefit payments under its insurance program.  If the balance is over $5,000 at the time of distribution, participants and surviving spouses of deceased participants will be offered annuity options as well as lump sum payouts.  Lump sum distributions to married participants will require spousal consent.  Balances of $5,000 or less will be distributed automatically as lump sums.  Both annuity options and spousal consent requirements are, it may be noted, very rare in individual account plans and entirely absent from rollover IRAs.

A precondition to utilizing either the notification or transfer version of the program will be a “diligent search” for participants for whom the plan administrator lacks valid current addresses.  A terminating plan must send election forms to participants (so that they can request direct roll­overs), so it is fairly easy to discover who is missing.

The subsequent search must be conducted within the six month period before account balances are transferred to the PBGC or disposed of in some other manner.  The search must be conducted in accordance with DOL guidance on fiduciary duties set forth in FAB 2014-01 rather than the more stringent rules that the PBGC imposes on defined benefit plans with missing participants.  If relatively simple and inexpensive methods – checking the records of other plans of the employer, contacting the participant’s designated beneficiary, sending a follow-up by certified mail, or using free Internet search tools – yield no results,

the duties of prudence and loyalty require the fiduciary to consider if additional search steps are appropriate. A plan fiduciary should consider the size of a participant’s account balance and the cost of further search efforts in deciding if any additional search steps are appropriate. As a result, the specific additional steps that a plan fiduciary takes to locate a missing participant may vary depending on the facts and circumstances.  Possible additional search steps include the use of Internet search tools, commercial locator services, credit reporting agencies, information brokers, investigation databases and analogous services that may involve charges.

From both employers’ and participants’ points of view, transferring funds to the PBGC may be an attractive option.  It is simpler and less costly than setting up IRAs or escrow accounts, increases the likelihood that missing participants and beneficiaries will be able to discover their entitlement to distributions (assuming that the PBGC’s database operates efficiently), and eliminates the prospect of escheat.  One negative is the relatively low return on transferred balances – the federal mid-term rate is currently around 1.3% – though IRA default investment options tend to be similarly unremunerative.  Perhaps the biggest potential concern is that new duties may overburden the PBGC, whose resources are already stretched thin, necessitating fee increases or leading to an ineffective program.

Multiemployer defined benefit plans.  Extending the missing participant program to PBGC-insured multiemployer plans was a natural step.  Very few of those plans close out after termination; unlike single employer plans, they may and usually do continue to operate as wasting trusts.  When one does close out, however, missing participants can be a major headache, since contact between the plan administrator and participants not in pay status is generally limited or non-existent, and a terminated multiemployer plan has, by definition, no remaining employers to furnish information.

The multiemployer program will be compulsory for eligible plans and will follow the same rules as the single employer plan program.  Hence, plans will have two options for dealing with missing participants’ benefits, namely, transfer the present value of the benefit (calculated using PBGC-prescribed actuarial assumptions) to the PBGC or purchase insurance company annuity contracts for the missing participants’ benefit.

Multiemployer 401(k) and other individual account plans will be eligible for the individual account program.  The defined benefit program will have no effect on them.

Defined benefit plans of small professional employers.  PBGC insurance coverage does not extend to defined benefit plans that are established and maintained by professional service employers and at no time have more than 25 active participants.  Not being within the PBGC’s purview, these plans have previously been left out of the missing participants program.  Under the proposed regulations, they would be eligible on a voluntary basis.

Plans in this group will have the same three alternatives as individual account plans, viz., ignore the missing participants program, notify the PBGC of how some or all missing participants’ benefits have been provided for (typically through the purchase of annuity contracts), or transfer assets to the PBGC to provide benefits for all missing participants.  The last option will require the payment of a one-time fee and will be subject to the same rules as transfers to single employer plans.  Both notifying and transferring plans will be required to conduct a “diligent search” that meets the standards of the regular defined benefit missing participants program.

Changes to the single employer program.  The proposal includes modifications to the current rules regarding what constitutes a “diligent search” for missing participants, the valuation of benefits transferred to the custody of the PBGC, and the benefit options available to participants and beneficiaries after they are located.  These rules will apply uniformly to single employer plans, multiemployer plans, and small professional employer plans that elect to take part in the missing participants program.

Probably of greatest interest are the proposed changes to the “diligent search” requirement.  A precondition for making use of any of the missing participant programs (including those that simply involve notifying the PBGC of the disposition of benefits) is the conduct of a “diligent search” for the missing benefit recipients.  This search must take place during the six-month period before assets are turned over to the PBGC, transferred to an IRA, or otherwise set aside for the intended recipient’s benefit.  The table below compares the mandatory search steps under the current missing participant program, the proposed revised program for defined benefit plans and the proposed program for individual account plans.  All of the listed steps must be completed before a participant may be regarded as missing; the order in which they are carried out is unimportant.  The stated objective of the PBGC’s revisions is to make its guidance on diligent searches “more robust” instead of relying almost wholly on plan administrators’ common sense.

None of the other changes to the current program is strikingly significant, but the PBGC unfortunately seems to have neglected one major change in the defined benefit plan universe.  Under its current rules, which the proposed regulations continue, if a missing participant dies before the PBGC finds him or her and begins paying his or her benefit, the benefit is forfeited, unless the date of death is after his or her “required beginning date” (April 1 of the calendar year following the year in which he or she attained age 70½).  Therefore, regardless of what the plan provisions may have said, the PBGC pays nothing to the beneficiary of an unmarried pre-70½ decedent and only a qualified preretirement survivor annuity (50% of the annuity that would have been payable to the participant during his or her lifetime) to the surviving spouse of a married participant.

At one time this rule reflected the practice of virtually all PBGC-insured defined benefit plans.  That is no longer the case.  Cash balance and pension equity plans almost invariably pay the value of a deceased participant’s accrued benefit to his or her surviving spouse or other beneficiary.  In addition, full vesting upon death is not at all rare in plans established by small professional employers.  The PBGC’s failure to pay survivor benefits in these instances may deprive survivors of substantial benefits and thus undercut one of the objectives of the missing participants program.

The PBGC has not set a target date for implementing the new programs.  Because the program’s formulation has taken much longer than anticipated (they were authorized ten years ago), the PBGC will probably try to move forward rapidly.  The program specifics do not appear to be very controversial, so the greatest delaying factor will probably be the time needed to develop and test the proposed unified database.

¹The PBGC’s forms and instructions may limit the need to undertake this step.