The federal government should take steps to clarify whether millions of dollars of retirement savings transfers to states from employer-based plans such as 401(k)s constitute reportable and taxable distributions, according to a report by the Government Accountability Office (GAO).
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Every year, large amounts of retirement savings assets are moved to states as unclaimed property, with only some of that amount later being claimed by owners, the GAO said in a January report commissioned by the U.S. Senate Finance Committee. These unclaimed balances often result from job changes, and may escheat to state treasuries if not taken back by owners after a certain amount of time.
Why Transfers Happen
Twenty-two states responded to GAO’s survey, and 17 provided data showing that a total of $35 million was transferred to them from employer retirement plans and individual retirement accounts (IRAs) in 2016. These transfers happen when retirement account owners don’t claim money from retirement accounts or cash checks from retirement plans. The funds may be transferred after a defined period, often 3 to 5 years of inactivity in the case of plan savings, to state unclaimed property offices. After the funds are transferred, the asset owners can claim their savings from the state.
Plan terminations also can result in unclaimed retirement savings if a terminating plan, which must distribute savings to complete the termination process, cannot obtain instruction from the account owner on what to do with the savings. According to the U.S. Department of Labor (DOL), 19,155 401(k) plans terminated in 2016, the report said.
More detailed information about 2016 claimed retirement savings transfers was provided by 15 states. They said owners claimed about $25 million in aggregate that year: an average $601 from uncashed 401(k) plan checks issued and an average $5,817 from traditional IRAs.
The states replying to GAO’s survey reported various methods of trying to locate owners and to maintain the value of these funds, including applying interest, while doing so. But it’s not possible for all funds to be claimed because owner information is not always available, especially when the transferred savings are small, GAO said.
Identifying and finding missing participants, for both defined benefit (DB) pensions and defined contribution plans like 401(k)s, already has been highlighted by retirement plan practitioners and benefits attorneys as a top DOL enforcement priority for plan sponsors in recent years (see August 2018 story).
Although the Internal Revenue Service (IRS) and the DOL have issued guidance on transferring retirement savings to states, the IRS has not clarified some responsibilities or ensured that the funds owners claim from states can be rolled over into other tax-deferred retirement accounts, GAO said.
“IRS is responsible for communicating and enforcing tax responsibilities, but has not specified whether 401(k) plan providers should report state transfers to IRS as distributions and withhold federal income taxes. IRS officials said the agency has not issued guidance to clarify this issue because of competing priorities,” the GAO report stated.
As a result of this absent guidance, 401(k) plan sponsor practices for state transfers vary—some withhold taxes when moving the savings to states and some don’t, the report said. This makes the IRS “less likely to collect federal income taxes that may be due if transfers are taxable events,” the report said.
Lost Chance for Tax Deferral
Also, when account owners are unable to roll over their reclaimed retirement savings, they forgo the chance to continue investing the funds on a tax-deferred basis, GAO said.
GAO further recommended that the IRS modify its list of permitted reasons for rolling over retirement savings after the official IRS deadline of 60 days to cover these unclaimed-savings situations for retirement plan account owners. The IRS allows individuals to roll over retirement savings after 60 days for several reasons, but none of them currently includes claiming 401(k) savings from a state.
The report said the IRS agreed with the GAO recommendations, and that the tax agency said it would work with the DOL to address related issues.
And GAO said the Secretary of Labor should specify the circumstances under which uncashed distribution checks from active plans can be transferred to the states.
The report, GAO-19-88, was built from a performance audit conducted from October 2016 to January 2019, and involved surveying 129 IRA transfer agent companies (21 responded) and 32 401(k) plan service providers such as recordkeepers (7 responded), in addition to surveying the 50 states and the District of Columbia.