United States: New Rules for Qualified Plans Automatic Rollovers of Involuntary Cash-Outs

The Economic Growth and Tax Relief Reconciliation Act of 2001 added a new rollover requirement for tax-qualified retirement plans that make involuntary cash-outs of small benefits. The Internal Revenue Service recently issued guidance on how that requirement should be administered.

Background

In general, participants must consent to distribution of their retirement benefits, choosing when and in what form to receive their benefit. However, when the present value of a participant's benefit is $5,000 or less, a plan may pay out that small benefit in one lump sum payment, without the participant's consent. Under the old law, a plan paid the small benefit directly to the participant, unless the participant opted to have the money rolled over into another employer's qualified retirement plan or to an IRA the participant designated.

Under the new law, small benefits greater than $1,000 but no more than $5,000 must be automatically rolled into an IRA selected by the plan administrator, unless the participant affirmatively elects to receive the cash or selects another IRA or qualified plan to receive the rollover. The new law was apparently intended to help short term employees save for retirement by changing the default distribution option to make it just a little more difficult to get a cash distribution.

Sponsors have 3 options for compliance, all of which require a plan amendment:

• Select an IRA provider and make automatic rollovers on and after March 28, 2005;
• Reduce the involuntary cash-out limit from $5,000 to $1,000, since only involuntary cash-outs of amounts greater than $1,000 trigger the automatic rollover requirements; or
• Eliminate involuntary cash-outs altogether.

Special considerations in selecting a compliance option:

• All sponsors should consider the additional administrative cost of retaining inactive participants who would otherwise have received a cashout.
• Sponsors of defined benefit plans should consider, in particular, the costs of paying very small annuities and the Pension Benefit Guaranty Corporation (PBGC ) premiums that will be due for participants who would otherwise have been cashed-out.
• Sponsors that decide to make automatic rollovers should consider the Department of Labor's safe harbor for selection of providers and investments.

Plans must be amended to comply with the new rules no later than the end of the first plan year ending on or after March 28, 2005. Thus, sponsors of calendar year plans must adopt a plan amendment by December 31, 2005. We recommend that you adopt a plan amendment as soon as possible after determining which option best suits your needs.

Selecting an IRA provider and making the initial investment choice for the rollover are fiduciary acts. The Department of Labor has issued safe harbor regulations that, if followed, will relieve fiduciaries of responsibility for involuntary cash-out amounts once they have been properly rolled over:

• The rollover must be made to an individual retirement account or an individual retirement annuity;
• Before any automatic rollover can be made, the plan sponsor must distribute an updated Summary Plan Description (SPD) or Summary of Material Modifications (SMM) to all participants; and
• The plan administrator must have a written agreement with the IRA provider that specifies:
• the initial investment option - typically a money market fund - offered by a state or federally regulated financial institution;
• that the fees and expenses charged by the provider cannot exceed the fees and expenses charged by the provider for IRAs that receive non-automatic rollovers; and
• that the participant has the right to enforce the agreement against the IRA provider.

If you amend your plan to reduce or eliminate involuntary cash-outs, you must distribute a revised SPD or an SMM to all participants no later than 210 days after the close of the plan year in which you adopt the amendment.

If you amend your plan to implement automatic rollovers, you must distribute two notices before any automatic rollovers are made:

• An SMM to all participants; and
• A notice to individual participants at the same time you distribute the Section 402(f) Special Tax Notice (either separately or incorporated into the Special Tax Notice).

In addition, information on automatic rollovers should be included in your next SPD revision.

If you implement automatic rollovers your plan may suspend processing of involuntary cash-outs until administrative procedures are in place and participant notices have been distributed. However, all suspended cash-outs must be made by December 31, 2005.

If you have a prototype plan, your prototype sponsor should already have provided you with amendment options and model notices to distribute to your plan participants. Make sure you have followed through with your prototype sponsor to properly amend your prototype plan for whichever option you choose.

If you have an individually designed plan, you'll need to decide on a compliance option, amend your plan accordingly, and communicate to plan participants. Please do not hesitate to contact us if you would like copies of our model amendments and participant notices, or if you have any questions regarding the new automatic rollover rules.