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Lost Participants and Unpaid Benefits

Posted Friday, August 12, 2016 by Linda M. Josephson

There has been a small flurry of concern about a change in the instructions for 2015 filings on Schedule H, of the Form 5500, the annual report file by all ERISA pension plans. Specifically, one question, Line Line 4l:

“Has the plan failed to provide any benefit when due under the plan?”

Formerly, the instructions for answering this question read:

You must check “Yes” if any benefits due under the plan were not timely paid or not paid in full. Include in this amount the total of any outstanding amounts that were not paid when due in previous years that have continued to remain unpaid.It has generally been answered by plans taking into account terms that require the plan’s normal administrative procedures for commencing a benefit be followed in order to initiate benefit payments.

The IRS acknowledges in its Internal Revenue Manual that a plan may contain such a provision, provided it also provides for the actuarial adjustments whenever the annuity starting date occurs after the participants’ normal retirement date (unless suspended by return-to-work rules). The 7th Circuit Court of Appeals came to the same conclusion in Contilli v Teamsters Local 705 Pension(559 F.3d 720 (7th Cir. 2009)).

New Instructions for Completing Line 4l

In an unannounced change for the 2015 plan year filings, the IRS’s instructions for Line 4l now read as follows:

Line 4l. You must check “Yes” if any benefits due under the plan were not timely paid or not paid in full. This would include minimum required distributions to 5% owners who have attained 70½ whether or not retired and/or non-5% owners who have attained 70½ and have retired or separated from service, see section 401(a)(9) of the Code. Include in this amount the total of any outstanding amounts that were not paid when due in previous years that have continued to remain unpaid.

While it may be contrary to the terms of a plan to fail to begin payment of a participant’s benefit at normal retirement age, the failure to begin a participant’s payment as of the required beginning date is of more consequence. It is a violation of Code §401(a)(9) minimum required distribution (“MRD”) rules, and so violating that rule technically risks the qualified status of the plan and trust. Additionally, there is a 50 percent excise tax that applies to payments that should have—but were not—paid in accordance with the MRD rules.

On July 29, 2016, the IRS offered a clarification of its instructions. Plans are not required to report participants past their required beginning date if either:

▪ They cannot be located after “reasonable efforts;” or

▪ Where the plan is in the process of engaging in such reasonable efforts at the end of the plan year reporting period.

It states that plans should use “one or more” of the search methods described in the DOL guidance to demonstrate reasonable efforts have been made to locate RMD-eligible missing participants.

Enforcement Initiatives

There are two initiatives, one at IRS and a second at Department of Labor (“DOL”), which it appears will be using the information gleaned through this and other channels.

First, the Employee Plans Compliance Unit (“EPCU”) has an open project on “failure to provide a benefit.” It appears that plans that indicate on Line 4l that they have participants with unpaid benefits will receive and information request from EPCU.

Second, there have also been reports in the media that the DOL has begun audits targeted on this issue. DOL views the failure to pay benefits when due as potentially a violation of the plan fiduciary’s duty to operate the plan in accordance with its terms and in the best interests of participants (which in this case would be the timely payment of the benefits they have earned).

So what steps should plans put in place as a matter of good compliance and, if necessary, to address operational noncompliance? Glad you asked.

“Reasonable Efforts” to Locate Lost Participants

As with all such claims, the fiduciary’s best defense is procedural: That the plan has administrative procedures in place that are intended and designed to locate and pay these participants their benefits.

IRS’s correction procedures (“EPCRS”) require that “reasonable actions” must be taken to find participants to whom benefits are due if a mailing to the last address of record is unsuccessful. If a participant is missing after a thorough search (and as suggested in DOL guidance, missing includes unresponsive participants as well as those that cannot be located) then “a plan will not be considered to have failed to correct a failure due to the inability to locate an individual…provided that, if the individual is later located, the additional benefits are provided to the individual at that time.” (IRS Revenue Procedure 2016-17, §4.04)

Locating Missing Participants: The DOL has addressed the steps for locating missing participants in the context of terminating defined contribution plans. This standard is looked to as a benchmark for plans generally. It has suggested the following strategies should be taken before a treating a participant is “missing”:

○ Certified mail

○ Check related plan and employer records (such as those of a related health & welfare trust or union local)

○ Check with the participant’s designated beneficiary

○ Use free electronic search tools, including Internet search engines, public record databases (such as those for licenses, mortgages and real estate taxes), obituaries and social media

IRS’ correction procedures contain a similar series of steps they recommend be taken:

○ Commercial locator services

○ Credit reporting agencies

○ Internet search tools

Document Procedures. Trust offices should review and document policies and procedures related to commencement of benefits and location of missing participants. The trust office should be prepared to disclose how many participants are on the rolls who have reached their:

○ Normal Retirement Date, are terminated and not in pay status (potentially contrary to the terms of the plan) or

○ Required Beginning Date, generally April 1 following the year in which they attained 70.5 – though some plans do employ a rule allowing commencement the later of the year following age 70.5 or termination.

Ideally, in each case in which benefit payments have not begun timely, and particularly by the participant’s required beginning date, the plan should be able to demonstrate its attempts to locate and communicate with the participant and to put the participant into pay status.

Correction

Under EPCRS there is a standardized filing for correcting RBD failures. Relative to other correction filings, the user fee may be relatively small, depending upon the number of participants affected: $500 if 150 or fewer participants are affected and $1,500 if 151 to 300 participants are affected. Standard user fees apply if more than 300 participants are affected.

Conclusion

With the IRS’s July 29 clarification of the Form 5500 instructions, the IRS and DOL in theory recognize that there will be delayed payments to participants due to no fault of the administrator. The clarification may still leave plans in a reporting quandary if “reasonable efforts” were not underway at the end of 2015 or have not been concluded prior to the Form 5500 due date. In anticipation of any informal inquiry and in particular because an IRS or DOL inquiry may foreclose self- or voluntary correction options, it would be advisable to audit plan records to ensure that:

● The proper procedures are in place and have been followed;

● Attempts to put missing participants into pay status can be documented if an inquiry is made; and

● Where necessary, corrective action has been taken.

Please contact us if you have questions or to discuss particular situations where commencement of benefits has been delayed.