We just discovered that one of our employees has been stealing money from the company for quite some time. We fired him as soon as we discovered the theft, and we are working with the police and our attorney to determine what recourse we have. The employee has enough in his 401(k) account with us to cover most of what he stole, but he has submitted a request to take a distribution from the plan.
Can we freeze the participant’s account in the 401(k) plan and potentially use it to recover our losses?
This is one of the very rare instances when there is a clear-cut answer, and it is a resounding “no.” We know—this probably isn't the answer you wanted.
One of the unique features of company-sponsored retirement plans is that they are protected from legal judgments and bankruptcies. They also cannot be used as collateral and cannot be assigned to another individual. There are a few exceptions, but they are very narrow and specific. Here is a quick rundown.
Qualified Domestic Relations Order
If a participant is going through a divorce or other family-law-type proceeding, his or her retirement accounts can be awarded to the former spouse or children via a QDRO issued by the court.
Crime Against The Plan
If a participant commits a crime against the plan, the account can be frozen and potentially used to restore the plan’s losses. It is important to note that a mere accusation is not enough to seize the account, so it is critical to work with legal counsel in situations like this.
In limited situations, the IRS may be allowed to place a lien on a participant’s account to recover a tax liability. There are quite a few steps to go through before this is an option, so it's a pretty rare occurrence.
Most states have laws that prevent a murderer from benefiting from his or her crime. Think: one family member killing another for the insurance proceeds. Even though federal law normally overrules state laws when it comes to retirement plans, the courts have ruled that state slayer statutes do apply in the context of retirement benefits.
Other than that, there really aren’t any other situations where a participant’s account can be involuntarily frozen or seized.
The facts presented do not seem to fit into any of these categories, so you would be in dangerous territory to freeze the account. How dangerous? A company intentionally interfering with a participant’s retirement plan rights has always been a big no-no, but Congress upped the ante in 2006 when it increased the penalties to monetary damages of up to $500,000 and up to 10 years in prison per occurrence.
Even though it might seem like a logical direction to go in, and even if the participant is completely on board with the idea, this is one of those situations where the easiest answer is not the best. We would highly recommend consulting an attorney who is knowledgeable in benefits law to help guide you. For more information on plan distributions, visit our Knowledge Center here.