Escheat and 403(b) Contracts

Does a 403(b) plan have the authority to voluntarily transfer the account of a missing plan participant or beneficiary under the state’s unclaimed property or escheat laws?   

State Law Terminology

In a January 2019 Government Accounting Office (GAO) report, “Retirement Accounts: Federal Action Needed to Clarify Tax Treatment of Unclaimed 401(k) Plan Savings Transferred to States,” the Department of Labor (DOL) distinguished between escheating a participant’s account to the state and transferring to the state an unclaimed participant account:

• A plan transferring participant’s account to the state, with the state indefinitely assuming ownership of that account in a custodial capability is operating under an unclaimed property law.
• Escheat occurs if the state assumes ownership of the participant’s account that was transferred by the plan. 

403(b) Contractual Provisions
 
To date, the impact of state unclaimed property and escheat laws on retirement plans have focused largely on plans qualified under Internal Revenue Code Section 401. However, 403(b) plans have an additional factor to be considered—unlike their qualified plan counterparts, a 403(b) contract must provide that “the employee's rights under the contract are nonforfeitable, except for failure to pay future premiums.” See Internal Revenue Code Section 403(b)(1)(C).

The IRS explains this concept of nonforfeitability: 

• amounts under a 403(b) contract are nonforfeitable if they are fully vested under the 403(b) plan: “the employee for whom the contract is purchased has at all times a fully vested and nonforfeitable right (as defined in regulations under section 411) to all benefits provided under the contract.” In other words, employee contributions, rollovers and vested employer contributions all would be considered nonforfeitable and thus under the 403(b) contract. See Treas. Reg. Sections 1.403(b)-3(a)(2).
• amounts not yet vested under a 403(b) plan technically are not considered to be under a 403(b) contract. That is, since such amounts are still forfeitable, they are considered tracked as 403(c) amounts (if held in a 403(b)(1) annuity contract) or 401(a) amounts (if held in a 403(b)(7) custodial account). See Treas. Reg. Section 1.403(b)-3(d)(2).

List of Required Modification (LRM) 65 (Vesting) of the 403(b) LRMs provides additional clarification regarding a 403(b) plan that has a graduated vesting schedule. “If only a portion of the Participant’s interest in a separate account becomes nonforfeitable in a year, then that portion of the contract will be considered a section 403(b) Annuity Contract and the remaining forfeitable portion will be considered a separate contract to which section 403(c) (or another applicable provision of the Internal Revenue Code) applies. Each contribution (and earning thereon) that is subject to a different vesting schedule must be maintained in a separate account for the Participant.”  

IRS and 403(b) Missing Participants

IRS information about the steps to locate missing participants does not apparently contemplate state unclaimed property or escheat laws for an ongoing retirement plan. The IRS’ Missing Participants or Beneficiaries webpage (last updated July 21, 2021)  suggests using commercial locator services, credit reporting agencies and internet search tools. The Employee Plans Compliance Resolution System (EPCRS, currently found in Rev. Proc. 2021-30, suggests similar techniques. 

The IRS does not address whether such state laws could be harmonized with the IRS’ 403(b) contractual nonforfeitable requirement. The current 403(b) LRMs do not include a sample plan provision addressing the protocol for a missing plan participant or beneficiaries. While the IRS’ 403(b) Examination Guidelines  address steps to be taken if the 403(b) plan has missing participants and beneficiaries who are subject to the minimum distribution requirement, those steps do not contemplate leveraging any state law mechanisms. See Internal Revenue Manual at Section 4.72.13.15.2(9).

Under the most conservative approach, this IRS silence could be construed as not authorizing state escheat or unclaimed property laws to apply to vested amounts under 403(b) products. At best, such silence could simply mean that this is an unsettled area of the law. In the absence of definitive guidance, an employer with a 403(b) plan should seek the advice of its legal counsel to determine the appropriate protocols to apply to vested accounts of missing 403(b) plan participants and beneficiaries. 

Linda Segal Blinn, J.D.*, is vice president of Technical Services for Tax-Exempt Markets at Voya Financial. In this capacity, Blinn leverages over 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans. 

This material was created to provide accurate information on the subjects covered. It is not intended to provide specific legal, tax or other professional advice. The services of an appropriate professional should be sought regarding your individual situation. These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document. The taxpayer should seek advice from an independent tax advisor. 

* Linda is not a practicing attorney for Voya Financial. 

Opinions expressed are those of the author, and do not necessarily reflect the views of the NTSA or its members.