Small Plan Balances – Choices and Compliance Risks

Small account balances in 401(k) plans have forever been a challenge for plan sponsors. The challenge primarily arises from the participant’s lack of interest in the small account balance.  Amounts above a certain value tend to command the attention of the participant and the participant is likely to respond to distribution notices and instructions.  But participants may ignore account values below a certain amount leaving the plan sponsor with administrative burdens and compliance concerns. Congress and the Department of Treasury have, over the years, attempted to help the situation by raising the automatic cash-out limit but no current regulatory solution exists for very small account balances that participants ignore. Plan sponsors have addressed this issue in a variety of ways.  These ways include:

• retaining small plan balances indefinitely
• forfeiting small plan balances for missing participants (but restoring them if the participant reappears)
• retaining small plan balances and allowing the balance to be worn away by administrative fees
• automatically cashing out all amounts and using extra efforts to communicate with the participants
   

There’s no perfect solution and each option has advantages and disadvantages –some including legal compliance risks. This article discusses the current legal compliance concerns with some of these approaches.

Follow the Plan Document

The primary legal concern that can arise with some of these “self-help” solutions is a failure to follow the terms of the plan document. Under ERISA, a plan administrator is obligated to follow the terms of the plan. Most prototype and volume submitter plan documents maintained by the large recordkeepers provide little flexibility when it comes to small balances. These plan documents typically automatically cash out all amounts below the chosen maximum (e.g., $5,000). A plan sponsor that adopts some administrative policy of retaining de minimis account balances to either forfeit them or allow them to be worn away with fees would violate the terms of these plans. That practice would invite a fiduciary breach claim.

Individually designed plans offer a different alternative. We have worked with some individually-designed plans that do provide for the forfeiture of small plan balances (e.g., under $1,000) where the plan administrator reasonably determines that the participant is missing or unresponsive after conducting a diligent search. The balance would, of course, be reinstated if the participant later appeared. The Treasury regulations do support this approach.  Nonetheless, it is critical that employers maintain complete and accurate records with respect to these participants and their account values and that the plan administrator follows current guidance on attempting to locate the missing participant.  Further, the practice should be disclosed in the Summary Plan Description. 

Act in the Best Interest of Plan Participants
Another legal risk with adopting a policy or practice of retaining de minimis accounts and forfeiting them or allowing them to be worn away with fees is a separate fiduciary risk. Under ERISA, a plan administrator must operate the plan and make discretionary decisions prudently and in the best interest of plan participants. A decision to retain these amounts is intended to primarily benefit the plan sponsor and plan administrator at the expense of the participant.  Reasons given for this approach include being able to avoid dealing with uncashed checks and avoiding the search for missing participants. Retaining small account balances and not distributing them in no way benefits the participant. ERISA requires the plan administrator to place the interests of the participants first and a failure to do so again, gives rise to a fiduciary breach claim.

Conclusion

So, at the end of the day, we see no risk free solution other than automatically cashing out all amounts consistent with the plan document or drafting your individually-designed plan to provide for a limited forfeiture right. 

Adam Gretis is a Partner with Seyfarth Shaw LLP.