Unclaimed Benefits and State Escheat Laws

From time to time we are asked whether a plan administrator must report and remit unclaimed plan benefit payments as abandoned or unclaimed property to various states under their escheat and unclaimed property statutes. Clients are usually asking about how to handle uncashed retirement plan benefit checks, and this post deals mostly with those types of benefits. In general, state laws requiring the transfer of unclaimed benefits that can be considered plan assets (like retirement benefits or benefits payable under a self-funded group health plan) and will remain plan assets if unclaimed are likely to be preempted by ERISA. If, however, the unclaimed benefits are not plan assets (such as certain insured benefits) and will not revert to the plan if unclaimed, the state escheat and unclaimed property statutes are not likely to be preempted by ERISA.

As most readers know, ERISA preempts any and all state laws that relate to employee benefit plans, except those that regulate insurance, banking, securities, and a few other areas of state law. ERISA § 514(a). Thus, ERISA does not preempt merely those state laws that conflict with ERISA, but broadly preempts all state laws related to employee benefit plans (other than laws that fall within one of the exceptions).

The DOL has confirmed that this broad preemption rule applies to state escheat and unclaimed property statutes. In the DOL's view, the application of these state laws to an ongoing employee benefit plan "would directly affect the core functions of the [p]lan by reducing, through escheat, the amount of plan assets held in trust for the benefit of all participants and beneficiaries of the [p]lan." ERISA Op. Ltr. 94-41A (Dec. 7, 1994). The DOL has maintained this position for over thirty years, and has used it to conclude that ERISA preempts the state escheat and unclaimed property statutes, as applied to employee benefit plans, of Texas, California, and Illinois. See id.; see alsoERISA Op. Ltr. 79-30A (May 14, 1979); ERISA Op. Ltr. 78-32A (Dec. 22, 1978).

The DOL has recognized only two instances in which an employee benefit plan may need (or want) to comply with state escheat and unclaimed property laws. First, an employee benefit plan generally needs to comply with state escheat and unclaimed property laws specifically regulating insurance contracts and any other state laws specifically excepted from ERISA section 514(a). For example, the DOL has stated that the section of New York's unclaimed property law addressing unclaimed insurance proceeds (other than life insurance) is saved from preemption under section 514 as a law regulating insurance. See ERISA Op. Ltr. 83-39A (July 29, 1983). Second, the DOL has stated that a fiduciary terminating a defined contribution plan may voluntarily decide to escheat missing participants' account balances under a state's unclaimed property statute in order to complete the plan termination process. DOL Field Assistance Bulletin 2004-02 (Sept. 30, 2004).

Courts considering whether state escheat and unclaimed property laws are preempted by ERISA have come to varying conclusions, though most are consistent with the DOL's interpretation of ERISA preemption. For example, the Second Circuit has held that ERISA did not preempt Connecticut's escheat law as applied to unclaimed life insurance benefits under an insured plan, because the unclaimed benefits would revert to the insurance company, not the plan, and the application of the escheat law in those circumstances would have only an indirect economic and administrative impact on the plan. Aetna Life Ins. Co. v. Borges, 869 F.2d 142 (2^nd Cir. 1989). The DOL has distinguished this case from its guidance and does not believe the two are in conflict. SeeERISA Op. Ltr. 94-41A.

Courts considering unclaimed benefits that are plan assets generally find that state escheat and unclaimed property laws are preempted by ERISA. See Commonwealth Edison Co. v. Vega, 174 F.3d 870 (7^th Cir. 1999) (considering the Illinois unclaimed property statute); see also Mfrs. Life Ins. Co. v. E. Bay Rest. & Tavern Ret. Plan, 57 F. Supp. 2d 921, 923 (N.D. Cal. 1999). These ruling are consistent with the position of the DOL, which has separately determined that ERISA preempts Illinois' unclaimed property statute. SeeERISA Op. Ltr. 78-32A.

As a practical matter, a plan may be able to avoid state escheat and unclaimed property laws if the plan provides for undistributed benefits to be forfeited or restored prior to the shortest applicable escheat/unclaimed property period. (Treasury Regulations section 1.411(a)-4(b)(6) allows a plan sponsor to forfeit the benefit of a missing participant or beneficiary if the plan document provides for reinstatement of the benefit in the event the participant or beneficiary makes a claim for the forfeited benefit.) We are aware that states have had some success in attacking these kinds of provisions in an attempt to reach unclaimed benefit checks from insured plans. But for the reasons explained above, we think ERISA would provide a strong defense against such an attack in the context of a retirement plan. Plans containing these types of provisions should, of course, address how the forfeited or restored amounts will be treated (and plan administrators should consult legal counsel before attempting to implement any of these provisions).

As for determining a participant or beneficiary is missing or unresponsive, we often advise fiduciaries to go through the procedures described in FAB 2004-02 – and to document the process – before cancelling the check and putting the benefit into a forfeiture account. A fiduciary need not go through the steps in the order listed, nor take each of the steps if one method is successful. Here's a quick run-down:

1. Certified Mail. Use certified mail to try to reach the participant.
2. Review Records. Check other plan records, such as the group health plan, for more current contact information. Also check any other employer records for a more current address or contact information, even e-mail.
3. Beneficiaries. Contact any individual the participant has designated as a beneficiary under the 401(k) plan or any other plan (such as term life insurance) for information concerning the location of the missing participant.
4. Letter-Forwarding Program. Use the IRS or Social Security Administration letter-forwarding program to attempt to locate the participant.

In addition, it may be appropriate to use a commercial locator service, internet search tool, or credit reporting service to try to locate the individual. Sometimes commercial locator services are more efficient and more successful than the other methods, and some employers take that as a first step. Many retirement plan vendors offer these and similar services, sometimes without a fee.