A More-Enlightened Approach to Uncashed Distribution Checks

By Thomas Hawkins | February 8, 2024

A_More-Enlightened_ApproachNo retirement plan sponsor likes the idea of dealing with uncashed distribution checks, nor do they wish to draw unwanted regulatory attention or to become embroiled in costly litigation because of their uncashed check policies.

Unfortunately, many plan sponsors place themselves in precisely that spot, becoming unnecessarily over-burdened with unresolved uncashed checks, while inviting unwanted regulatory scrutiny and/or legal challenges by embracing flawed uncashed check policies.

A more-enlightened approach to managing the problem of uncashed checks seeks to minimize their numbers, while simultaneously steering clear of the “red flags” that could land them in hot water.

Flaws, Red Flags & Litigation
The process of handling retirement plan distribution checks is inherently flawed – including an antiquated medium (physical checks), an unreliable distribution system (mail or courier), and the famously fickle behaviors of terminated participants. The process itself seems like punishment, and it’s the most important driver of uncashed checks.

Keeping below the regulatory radar is a numbers game. Too many uncashed checks will draw greater regulatory scrutiny and could be perceived a “red flag” that triggers a plan audit.

While the absence of sound uncashed check policies is another regulatory red flag, the presence of potentially unsound policies can also draw unwanted attention. For example, the prevailing practice of using a forfeiture expense account, often funded by uncashed checks, has become a target for litigation in a new round of ERISA class action lawsuits, exposing plan sponsors to a new source of fiduciary headaches.

The Importance of Managing Small Balance Accounts
Consider these statistics concerning small balance accounts in America’s defined contribution system:

  • According to EBRI data, about one-third of all defined contribution accounts have a balance below $7,000
  • In the Retirement Clearinghouse Auto Portability Simulation (APS), that translates into an estimated 6.2 million participants with less than $7,000 who will change jobs each year
  • Of these, around 2.5 million participants per year will leave behind balances below $1,000

Why are sub-$1,000 balances so important? That’s the level below which plan sponsors are permitted to automatically cash out terminated participants’ balances. Unfortunately, these automatic cashouts produce a blizzard of uncashed checks. Multi-year data from a mega-plan sponsor (250,000+ participants) reveals that around 10.5% of sub-$1,000 distribution checks go uncashed and must eventually be resolved.

A better approach would be to include these sub-$1,000 balances in an automatic rollover program, rolling over these balances (and others, up to $7,000) to a safe harbor IRA and dramatically reducing the volume of uncashed checks. Upon opening and funding of safe harbor IRAs, a plan sponsor is deemed to have fulfilled their fiduciary responsibilities. By contrast, with uncashed checks their problems are just beginning.

A more-enlightened approach would be to adopt auto portability, which delivers all of the benefits of automatic rollovers but without the flaws of a safe harbor IRA – such as high fees, ongoing high cashout rates and sub-optimal investments. By default, auto portability promotes the transfer of these balances to a current employer’s active account. This action promotes consolidation, lowers participant cashouts, more appropriately invests savings, and serves to close the racial wealth gap. For a current list of recordkeepers who have joined the Portability Services Network, an industry-led consortium dedicated to the widespread adoption of auto portability, visit this link.

Missing Participants – A “Red Flag” for Uncashed Checks
A March 2018 survey by Boston Research Technologies revealed that 11.3% of terminated 401(k) accounts have a stale address, suggesting that there are, at minimum, 3.1 million 401(k) missing participant accounts. Subsequent research by Retirement Clearinghouse indicates an even larger problem with stale addresses for terminated participants with no obvious "red flags" (ex. - returned mail).

The DOL clearly associates missing participants with uncashed checks in their 2021 missing participant guidance, where they noted that “a substantial number of stale uncashed distribution checks” is a “red flag” that is a warning or indicator of a “problem with missing or nonresponsive participants.”

The implications for plan sponsors are obvious – if you work to reduce missing participants, you should realize a significant reduction in uncashed checks resulting from returned or misdirected mailings.

Accordingly, enlightened plan sponsors should periodically update their records for lost or missing participants, employing cost-efficient electronic, or “e-Searches” that greatly increase the odds that mailed, physical distribution checks will reach their intended destination.

A More-Enlightened Approach
By taking a more-enlightened approach to uncashed checks – which includes addressing the associated issues of small balance accounts and missing participants, and avoiding policy missteps – plan sponsors can minimize their uncashed check problem, reduce their fiduciary risk and improve participant outcomes.