New IRS Guidance for Escheatment Makes Automatic Rollover IRAs Even More Attractive | Schwab - Millennium Trust Company

New IRS Guidance for Escheatment Makes Automatic Rollover IRAs Even More Attractive

January 6, 2021
By Millennium Trust
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The IRS recently released two pieces of guidance regarding the transfer of small qualified retirement plan account balances to state unclaimed property funds. The publications clarify tax treatment and rollover rules. They also may cause employers and plan administrators to reconsider whether the option is a sound choice for plan fiduciaries.

In October 2020, the IRS published:

  1. Revenue Ruling 2020-24, which posits that a plan administrator moving an account balance of less than $1,000 to a state unclaimed property fund must withhold taxes from the distribution. In addition, the distribution must be reported as taxable on Form 1099-R. Taxable distributions from qualified retirement plans typically are subject to mandatory withholding of 20%.
  2. Revenue Procedure 2020-46, which establishes that an individual who has an account balance escheated to the state from a qualified plan or individual retirement account (IRA) can request a waiver of the 60-day rollover deadline for qualified plan distributions, as long as certain requirements are met.

Clarification of the rules doesn’t move escheatment up in the hierarchy of plan best practices. In fact, it appears to add a new item to the list of reasons that transferring small balance accounts belonging to missing or nonresponsive participants to state unclaimed property funds is not a best practice. The long and short of it is that these transfers can negatively affect retirement outcomes. For instance:

  • Amounts withheld for taxes may be unrecoverable. In order to keep retirement savings intact through a rollover, individuals must replace the 20% withheld for taxes. If they cannot, then a portion of their tax-advantaged retirement savings is lost. Often, small accounts left behind belong to younger workers or members of low-income families. Both groups may have difficulty replacing amounts withheld for taxes.
  • States do not pay interest on assets in unclaimed property funds. This impairs former participants’ ability to reach their retirement goals.
  • Escheatment can result in the loss of all retirement savings. Some states allow owners to claim their property at any time. Others, however, permanently transfer unclaimed property to the state after a period of time. If that occurs, participants lose their retirement savings.

Transferring small account balances to unclaimed property programs is not the only or the best option available to plan sponsors and administrators. The Economic Growth and Tax Relief Reconciliation Act of 2001 and regulations thereunder provide a safe harbor for the rollover of small balances into an IRA.

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The material in this blog is presented for informational purposes only. Millennium Trust Company performs the duties of a directed custodian, and as such does not sell investments or provide investment, legal or tax advice.

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