A New Retirement Risk: Unclaimed Property Laws
Retirement planning can be extremely complex. I often describe it as trying to hit a moving target in the wind. The target is moving because an individual does not know with any certainty the exact date retirement will begin or the duration of the retirement period. This means there is no way an individual can aim for a “magic” retirement savings amount. There is also the dynamic of wind because laws change, markets change, individual goals change, and the world changes. As a result, the path from day one of retirement to day 10,950 of retirement (assuming 30 years of retirement), follows anything but a straight line.
One of the best pieces of advice for accumulating savings for an uncertain retirement period is to “set it and forget it,” or “stay the course.” Many individuals harm themselves by trying to time their investments to the fluctuations of the market and by constantly trading stocks in pursuit of maximum returns. The reality is that average individual investors are really not very good at this strategy. Staying the course remains the soundest advice for most investors. However, staying the course without paying close attention to the winds of change could now produce some hazardous implications for retirees in some states.
Most people are aware of the existence of the Unclaimed Property Laws in their states. Every state has a law that requires financial institutions to report abandoned and unclaimed personal property after a specified time period. In most states, as part of the Uniform Unclaimed Property Act, the time period for property to be reported to the state is typically three or five years after it has been deemed to be either abandoned or unclaimed. These time periods vary state-by-state, and also vary by the type of property involved.
The traditional unclaimed property laws essentially gave the individual three years after reaching age 70.5, or five years after the inheritance of a retirement account, like an IRA, 401(k), or defined-benefit plan before the rules kick in and an individual would need to take action. This is really important, because if the state takes your unclaimed IRA or 401(k), it essentially liquidates the account and takes the money out of the tax-deferred shelter. In this event, the unclaimed property now becomes subject to income taxes. Even if the individual finds an unclaimed retirement account property later on, there will likely be substantial back taxes to be paid, and the tax-deferred nature of the retirement account will have been lost.
Traditional unclaimed property laws deferred the state capture and liquidation of these accounts until after a required minimum distribution would have occurred at age 70.5, or until death. Even though the tax implications of the state claiming a retirement account are painful, the rules made sense. However, in the past few years a new movement might be brewing that would empower states to treat retirement accounts as abandoned property much sooner.
In 2016, Pennsylvania enacted an unclaimed property rule that essentially treats retirement accounts no differently than all other accounts. After just three years of inactivity, regardless of the account holder’s age, the account will now qualify as unclaimed property. You are still allowed to claim your property into perpetuity, but the account will be liquidated and placed in the Commonwealth of Pennsylvania’s General Fund. This means that ordinary income taxes are owed on the entire amount and, in addition, there will likely be a 10 percent penalty tax for early withdrawal from your account, if done prior to age 59.5.
According to Jeffery Levine, CPA/PFS, CFP®, CWS®, MSA , CEO and Director of Financial Planning, “should your IRA or other retirement account be liquidated in such a manner, after reclaiming the funds from the State, there may be a way to roll the money back into a retirement account to avoid income taxes and early distribution penalties.” In a 2016 private letter ruling (PLR 201611028), the IRS allowed a taxpayer whose abandoned retirement accounts had been liquidated by his state to complete a late 60-day rollover after the funds were recovered. It’s likely the IRS would grant similar relief to taxpayers in a similar situation today. However, Mr. Levine noted that “there’s a catch. A big catch. The price tag to ask IRS for that relief will cost you five-figures… and that’s before you pay professional fees to a CPA, attorney or other qualified professional to help you with your request.”
This new law in Pennsylvania, which was widely criticized as a deviation from standard practices and removed protections for investors that typically allow retirement accounts to be protected from escheatment until much later, typically age 70.5. This change puts a substantial burden on anyone with accounts held in Pennsylvania. This means you should continue to log into your accounts every year, check the balances, and make sure your contact information is current. It’s also a good idea to make sure you know the definition of “inactive” that applies to your accounts. For instance, automatically reinvested dividends or interest may not be enough to qualify to keep your account in “active” status on their own, even though additional shares are being purchased on an ongoing basis. The same may also be true of automatically recurring distributions sent to banks or other accounts.
If you think this rule doesn’t impact you because you don’t live in Pennsylvania, think again. Since the rule requires financial institutions to report the abandoned property, it applies to the financial institutions in Pennsylvania, specifically mutual-fund giant Vanguard, with more than $3 trillion in assets. While there is some disagreement as to whether the Employee Retirement Income Security Act (ERISA) preempts any of these state abandoned property laws, the general consensus is that only fully insured plans and defined-benefit plans are protected from the unclaimed property laws. That is because sending money to the state in fulfillment of the new unclaimed property laws would decrease funding for all participants. As such, IRAs, Roth IRAs, and 401(k)s seem fair game under Pennsylvania law.
PA’s law has been widely criticized. The Investment Company Institute (ICI) even went so far to call the initial law “an asset grab by the state.” Pennsylvania Treasury denied this assertion. However, after receiving feedback from various stakeholders, Pennsylvania Treasury published Policy Guidance suspending enforcement of portions of the law relating to the abandonment of retirement accounts until further guidance is issued by the Treasury or the law is changed. This appears to be a commonsense response but the fact remains that the law is still on the books.
To help protect yourself against unclaimed property laws, make sure your contact information is always up-to-date, log into the account each year, respond promptly to any requests about your account, and stay engaged with your finances. Inactivity for long periods of time could cause your account to escheat to the state, resulting in thousands of dollars of unanticipated additional taxes and penalties. This would not be welcome news to anyone on the already treacherous road to a financially secure retirement.