The United States Government Accounting Office (GAO) has studied the escheat and tax treatment of unclaimed retirement funds, resulting in recommendations to the Department of Labor (DOL) and Internal Revenue Service (IRS) for further action. At the recommendation of the GAO, the DOL has agreed to review its position concerning the broad preemption of state unclaimed property laws by the Employee Retirement Income Security Act (ERISA), as it applies to uncashed distributions from 401(k) plans. The outcome could be that such distributions are reportable to the states as unclaimed property in the future. Similarly, the IRS has agreed to a recommendation by the GAO to provide guidance on the tax withholding and reporting that will apply when terminated 401(k) funds are escheated to the states. Additionally, the IRS has agreed to provide a mechanism to return retirement funds to a tax advantaged retirement account once those funds have been reclaimed by owners from the states.
Over the last 35 years, the DOL has made repeated administrative pronouncements that ERISA generally preempts state unclaimed property law.1 That broad interpretation of preemption will now be reevaluated by the DOL as a result of recommendations found in a GAO report released on February 19, 2019. The report, Retirement Accounts: Federal Action Needed to Clarify Tax Treatment of Unclaimed 401(k) Plan Savings Transferred to States (the Report), was presented to the Ranking Member of the U.S. Senate Finance Committee. In the Report, the GAO explores the escheat and tax treatment of unclaimed retirement funds. Based on the findings, the GAO has issued recommendations to both the IRS and the DOL, which could result in (1) a requirement for holders to report uncashed 401(k) distributions from active plans as unclaimed property, and (2) a change to the tax treatment of 401(k) funds reported as unclaimed property.
The Report details information gathered by the GAO including information on (1) how much in retirement savings is transferred to states as unclaimed property and what happens to those savings once transferred and (2) the steps the IRS and the DOL have taken to oversee these transfers and what improvements are needed.2
The GAO investigation uncovered some surprising statistics. Although one might have expected that most reported retirement funds would originate from unclaimed individual retirement accounts (IRAs) that are not covered by the DOL’s preemption position, that was not the case. The GAO found that during a sampled time period, the majority of retirement funds transferred to the states as unclaimed property included amounts from 401(k) plans. Digging deeper, however, the study revealed that most of the 401(k) funds reported as unclaimed property were from terminated 401(k) plans, because funds from terminated 401(k) plans can fall outside the scope of the DOL’s preemption position. Such funds can be transferred to the states as unclaimed property if a terminating 401(k) plan sponsor first takes certain steps to contact the owners, as outlined in federal guidance.
Other interesting statistics found in the Report are:
- Assets and uncashed checks from employer retirement plans were the most common form of retirement savings transferred to states as unclaimed property.
- Because most of the reported 401(k) funds were from terminated plans, individuals who were younger than 70½ were most affected.
- Some providers reported that they only transfer 401(k) funds to states when plans terminate.
- Transfers from IRAs only accounted for 16 percent of the retirement savings accounts transferred to the states responding to the survey.
- Most of the unclaimed savings from IRAs transferred to the states were for individuals older than 70½.