Washington Insights – Spring 2019

March 22, 2019 | By Jon Vogler

Jon Vogler
Senior Analyst,
Retirement Research,
Invesco Consulting

A new report from the Government Accountability Office (GAO) calls on federal regulators to clarify the rules regarding the transfers of unclaimed savings from employer-based 401(k) plans to the states.

In this edition of Washington Insights, we explore the findings and recommendations in the GAO report, as well as the unexpected manner in which accounts may be considered to be “abandoned” for purposes of some state laws on “escheatment” (i.e., forfeiture).

 

The GAO report (titled “Federal action needed to clarify tax treatment of unclaimed
401[k] plan savings transferred to states”) examines how much in retirement savings is transferred to states as unclaimed property, what steps the Internal Revenue Service (IRS) and Department of Labor (DOL) have taken to oversee these transfers, and what improvements are needed.1

The report finds that retirement savings are transferred to states under a variety of circumstances, including uncashed checks from active 401(k)-type plans (such as required minimum distributions payments), small account balances from terminating plans, and uncashed checks and account balances from individual retirement accounts (IRAs). The report also finds that states receiving these amounts and holders transferring amounts to the states have different procedures for handling the transfers. For example, some states liquidate securities immediately, while some do not. Additionally, some plan recordkeepers report such transfers as taxable distributions and apply withholding, while some do not.2

As one instance, individuals changing jobs throughout their careers can lead to lost and unclaimed savings, resulting in millions of dollars in retirement savings being transferred to states as unclaimed property — only some of which is later claimed by owners. In its research, the GAO found that of the 22 states responding to its survey, 17 states provided data indicating that they received $35 million in unclaimed retirement savings from employer plans and IRAs in 2016. Assets and uncashed checks from employer plans were the most common form of retirement savings transferred to states. After funds are transferred, owners can claim their savings from the state. According to the 15 states providing data on this, owners claimed about $25 million in retirement savings in 2016. States reported using a range of strategies to maintain the value of retirement savings while holding these funds, such as applying interest.3

“Without IRS clarification on whether transfers should be reported to IRS as distributions and when they should be subject to federal income tax withholding, not all plan service providers can be certain about the appropriate actions to take,” the GAO explains.1 This can affect not only the collection of federal income tax withholding, but also individuals’ retirement security, the agency notes.

Recommendations and agency response

The GAO makes the following recommendations in its report:4

  1. The IRS Commissioner should work with the Department of the Treasury (Treasury) to consider clarifying if transfers of unclaimed savings from employer-based plans (such as 401[k] plans) to states are distributions; which (if any) tax reporting and withholding requirements apply; and when they apply.
  2. The IRS Commissioner should work with the Treasury to consider adding retirement savings transferred to states from terminating defined contribution (DC) plans to the list of permitted reasons for rolling over savings after the 60-day rollover period, in a form consistent with the rules adopted on the taxation of transfers of unclaimed retirement savings. IRS Revenue Procedure 2016-47 provides a self-certification procedure available for taxpayers seeking a waiver of the 60-day deadline for rollovers, under certain pre-approved circumstances. An IRS news release describing the guidance is available at: https://www.irs.gov/newsroom/new-procedure-helps-people-making-ira-and-retirement-plan-rollovers
  3. The Secretary of Labor should specify the circumstances, if any, under which uncashed distribution checks from active plans can be transferred to the states.

In response to the first two recommendations, the IRS noted that it will work with the Treasury to address them. In its response, the DOL stated it plans to continue to evaluate whether there are circumstances in which the transfer of uncashed distribution checks from an ongoing plan to the states advances the goal of reuniting missing participants with their savings.

ICI report on “abandoned” accounts

According to the Investment Company Institute (ICI), many investors are unaware of new changes to the rules governing when and how retirement savings accounts are deemed “abandoned” by the investor and taken by their state government.

Tami Salmon, ICI Associate General Counsel, observed in a recent “ICI Focus on Funds” that states have changed how they deem accounts abandoned.5 It used to be they deemed them abandoned if somebody had moved and had not left a forwarding address, such that mail from financial institutions sent to that shareholder was sent back to the financial institution.

Now, however, Ms. Salmon notes that a person can be living at the same address and change nothing about their account status, yet be deemed to have abandoned their account simply because they have not affirmatively reached out and contacted that financial institution at least once every three years — even if they are continuing to receive statements and have no reason to contact the financial institution.

Consider a shareholder with an IRA account who lives in a state where they must contact their financial institution every three years. Under the IRS’ guidance, if the shareholder fails to initiate contact with their financial institution within three years, they may owe a 10% penalty when that account escheats. The account holder is expected to liquidate that IRA position, pay 10% to the IRS and give 90% to the state. When the shareholder finds out that their IRA account has been transferred to the state, they can contact the state to get it, but they’ve lost out on the 10% penalty that they had no control over (as well as the growth that could have occurred over time since the state claimed and liquidated the account). Ms. Salmon points out that this puts a burden on a shareholder that they’ve never had before to affirmatively contact their financial institutions to preserve their accounts.

While the ICI is engaging with the states to reconsider these actions, the shareholder has a role to play in this to protect their accounts, according to Ms. Salmon.6

Summary

The GAO report (issued in response to a request from Sen. Ron Wyden, D-OR, the ranking member of the Senate Finance Committee) examines issues related to the transfer of retirement savings to the states as unclaimed property. To better ensure that federal taxes are properly applied and better protect the retirement security of individuals affected by these transfers, the report recommends that the IRS consider clarifying whether transfers from employer-based plans to states constitute reportable and taxable distributions, and consider modifying its list of permitted reasons for rolling over savings after the 60-day rollover deadline.3 In addition, the report suggests that the DOL specify any circumstances under which uncashed distribution checks from active plans can be transferred to the states.

The ICI observes that in some states, an account can be considered abandoned and transferred to the state if the shareholder does not affirmatively reach out and contact the financial institution which holds the account at least once every three years. The shareholder can get the account back from the state when they become aware of the “forfeiture,” but typically minus the 10% penalty taken from the IRA (and any growth in the account from the point of transfer).

1 NAPA Net, “Regulators urged to clarify tax treatment of unclaimed 401(k) balances,” Ted Godbout, Feb. 21, 2019
2 ICI, “GAO report recommends IRS and DOL guidance relating to unclaimed retirement savings transferred to states,” Elena Barone Chism, Feb. 21, 2019
3 PlanSponsor, “GAO asks for more guidance on DC plan assets transferred to states,” Rebecca Moore, Feb. 22, 2019
4 SPARK Institute, “GAO report on 401(k) unclaimed property cites to SPARK member input,” Michael L. Hadley, Feb. 21, 2019
5 ICI Focus on Funds, “Protecting against an unpleasant surprise to your fund savings,” Tami Salmon, Feb. 22, 2019
6 ICI, “How to protect yourself from being deemed a “lost” mutual fund shareholder”

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding tax penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax advisor for information concerning their individual situation.