What happens when 401(k)s are orphaned by employees? Like any other unassigned assets, they’re transferred to the states and held as unclaimed property.
So how much is out there, and how is the transfer treated for tax purposes?
The Government Accountability Office asked the IRS (and the states themselves) for clarification.
States
“Of the 22 states responding to GAO’s survey, 17 states provided data indicating that $35 million in unclaimed retirement savings was transferred to them from employer plans and individual retirement accounts in 2016,” the GAO reports.
Assets and uncashed checks from employer plans (such as 401k plans), were the most common form of retirement savings transferred to states.
According to the 15 states providing data on this, owners claimed about $25 million in retirement savings in 2016—$601, on average, from 401k plan checks, and $5,817, on average, from traditional lRAs.
Interestingly, the states reported using a range of strategies to maintain the value of retirement savings while holding these funds, such as applying interest.
The states also reported various efforts to locate owners.
IRS
The IRS and the Department of Labor have issued guidance on transferring retirement savings to states; however, IRS has not clarified certain responsibilities or ensured that the retirement savings that owners claim from states can be rolled over into other tax-deferred retirement accounts.
IRS officials said the agency has not issued guidance to clarify this issue because of competing priorities.
As a result, 401k plan provider practices vary—some providers withhold taxes when transferring savings to states while others do not. This makes the IRS less likely to collect federal income taxes that may be due if transfers are taxable events.
IRS also has not acted to ensure that individuals who claim 401k savings from a state can roll over these savings to other tax-deferred retirement accounts after IRS’s 60-day deadline. Account owners who are unable to roll over their reclaimed savings forgo the opportunity to continue investing the funds on a tax-deferred basis.
Recommendations
GAO made three recommendations:
- The IRS Commissioner should work with the Department of the Treasury to consider clarifying if transfers of unclaimed savings from employer-based plans (such as 401(k) plans) to states are distributions, what, if any, tax reporting and withholding requirements apply, and when they apply.
- The IRS Commissioner should work with the Department of the Treasury to consider adding retirement savings transferred to states from terminating 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
- The Secretary of Labor should specify the circumstances, if any, under which uncashed distribution checks from active plans can be transferred to the states.
The IRS agreed with the recommendations and noted that it will work with the Department of the Treasury to address them.
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
