Retaining account
balances for terminated participants in a qualified retirement plan
often increases the plan’s administration expenses and fiduciary
responsibility. Therefore, many plans include what is known as a
"mandatory distribution" or "cash-out" provision to force the
distribution of small account balances to terminated participants
who fail or refuse to make an election either to receive the
distribution in cash or roll it over to an Individual Retirement
Account (IRA) or another qualified plan.
In order to preserve retirement savings for participants,
effective March 28, 2005, new Department of Labor (DOL) regulations
require that mandatory distributions between $1,000 and $5,000 be
rolled over to an IRA on behalf of the participant rather than
distributed in cash. These rules will also provide a means of
rolling over small account balances for participants that cannot be
located. The DOL has also extended reliance on these rules to lost
participants in a terminating defined contribution plan.
This newsletter summarizes the new automatic rollover procedures
and how they will ease the problem of making distributions to
certain participants who cannot be found or refuse to make an
election.
Background
One of the provisions included in the Economic Growth and Tax
Relief Reconciliation Act of 2001 (EGTRRA) is the requirement that
plans providing for mandatory distributions must automatically roll
over the distribution to an IRA on behalf of the participant, unless
the participant affirmatively elects to receive the distribution in
cash. This requirement is applicable if the vested account balance
is between $1,000 and $5,000.
These rules were not to become effective until the DOL drafted
safe harbor provisions that would protect plan fiduciaries from
liability. On September 28, 2004 the DOL issued final regulations
outlining the safe harbor rules which apply to mandatory
distributions made on or after March 28, 2005.
Safe Harbor Requirements
Complying with the safe harbor requirements provides fiduciary
protection for both the selection of an IRA provider and the
investment of the funds. The safe harbor relief is contingent upon
the plan fiduciary satisfying the following conditions:
Rollover Amount: An automatic
rollover is required for mandatory distributions that are $5,000 or
less but more than $1,000. The amount is determined as of the date
the distribution is to be made. If the plan disregards amounts that
the participant previously rolled over to the plan in determining
whether the cash-out limit has been exceeded, it may also disregard
these rollover contributions for automatic rollover purposes. If the
plan so elects, the automatic rollover rules may also be applied to
distributions of less than $1,000.
Individual Retirement Plan: The
rollover must be made to a traditional IRA (not a Roth IRA) or an
individual retirement annuity offered by a bank, insurance company
or other financial institution.
Written Agreement:
The plan fiduciary must enter into a written agreement with the
IRA provider that addresses, among other things, the investment of
the rollover funds and the fees and expenses to be charged to the
account. One or more IRA providers may be selected. The plan
fiduciary may rely on the IRA provider’s commitments set forth in
the agreement and is not required to monitor the IRA provider’s
compliance with the terms of the agreement once the rollover has
occurred.
Permissible Investments: The
rollover funds must be invested in a vehicle "designed to preserve
principal, and provide a reasonable rate of return, whether or not
such return is guaranteed, consistent with liquidity," such as money
market funds, interest-bearing savings accounts, certificates of
deposit or other "stable value products" offered by a bank, savings
association, credit union, insurance company or mutual fund.
Fees and Expenses: The fees
assessed against the IRA cannot exceed the amounts charged by the
IRA provider for comparable IRAs established for rollover
distributions that are not automatic rollovers.
Notice to Participants: All
participants are required to receive notification of the automatic
rollover provisions. This information must be included in the plan’s
Summary Plan Description (SPD) or a Summary of Material
Modifications (SMM).
Prohibited Transactions:
The fiduciary may not engage in a prohibited transaction,
such as a plan fiduciary receiving consideration from a financial
institution in exchange for selecting that financial institution as
the IRA provider. A class exemption permits a bank or other
financial institution to select itself to receive automatic
rollovers from its own qualified plan and utilize its own funds or
investment products.
If the automatic rollover safe harbor requirements have been
satisfied, the plan sponsor’s fiduciary responsibilities end
immediately upon the transfer of the participant’s benefit to the
IRA, and the distributed amount ceases to be a plan asset.
Lost Participants
In these times of high employee turnover, many retirement plans
find themselves owing benefits to former employees whose whereabouts
are unknown. This can be troublesome for ongoing plans since, in
many cases, the administrative costs are high related to the
participants’ account balances. If the plan permits mandatory
distributions and the distribution is $5,000 or less, the new
automatic rollover procedures provide a method of distributing the
vested account balance from the plan (mandatory distributions from
an ongoing plan are not permitted if the vested balance exceeds
$5,000).
Welcome Relief For Terminating Defined
Contribution Plans
A terminated defined contribution plan is required to distribute
all plan assets as soon as administratively feasible after the date
of plan termination. Participants are required to be notified of the
plan termination and given a choice of receiving a distribution or
having it directly rolled over to an IRA or another qualified plan.
When participants are lost or do not respond to written notices,
plan administrators often are faced with an array of fiduciary
issues and are unable to effectively wind-up the plan’s financial
affairs.
Recognizing this problem, the DOL released Field Assistance
Bulletin 2004-02 on September 30, 2004 outlining the fiduciary
obligations for a terminated defined contribution plan, including
mandatory search methods for locating a missing participant and
steps for distributing an account balance when efforts to locate the
missing participant fail. The DOL guidance for terminated defined
contribution plans is effective immediately.
Mandatory Search Methods
The DOL requires that every plan must employ the following search
methods regardless of the size of the missing participant’s account
balance. The plan should retain documentation to prove that attempts
to contact the participant were unsuccessful. Reasonable expenses
incurred attempting to locate missing participants may be charged to
the participant’s account.
Use Certified Mail:
Sending certified mail to the participant’s last known address
can easily ascertain whether the participant can be located in order
to distribute benefits.
Check Related Plan Records:
Determine whether the employer’s records or the records of another
plan maintained by the employer, such as a group health plan, has a
more current address.
Check With Designated Plan Beneficiary:
Attempt to identify and contact any individual that the missing
participant has designated as a beneficiary.
Use a Letter-Forwarding Service:
Use either the IRS or the Social Security Administration (SSA)
letter-forwarding program in an attempt to locate missing
participants. A Social Security number is required to use these
programs. In general, both the IRS and SSA search their records for
the most recent address of the participant and forward a letter from
the plan fiduciary to the participant. The IRS and SSA cannot
provide the plan with any information concerning the results of
their efforts. Hopefully, the letter from the plan will cause the
participant to contact the plan directly.
Other Search Options
If none of the four mandatory search methods is successful in
locating the participant, the plan fiduciary needs to consider
whether, under the facts and circumstances, it would be prudent to
use other methods, such as Internet search tools, commercial locator
services and credit reporting agencies. If the cost of using these
services will be charged to the participant’s account, the plan
fiduciary will need to consider the size of the participant’s
account balance in relation to the fees that would be incurred when
deciding whether to use any of these alternatives.
Distribution Options
If the fiduciary is unable to obtain a participant’s election
concerning the distribution of benefits or a prudent search does not
locate a missing participant, the plan may proceed with the
distribution of the participant’s account balance. The preferred
method is to roll the participant’s account balance into an IRA, and
fiduciaries may rely on the automatic rollover safe harbor rules
described above. In general, if all of the safe harbor rules are
satisfied, the amount rolled over may exceed $5,000, unless the plan
offers an annuity option or the employer, or a related company,
sponsors another defined contribution plan.
If a plan offers an annuity option, such as required in a money
purchase pension plan, distributions in excess of $5,000 must be in
the form of an annuity contract or irrevocable insurance commitment.
If the employer maintains another defined contribution plan (other
than an ESOP), accounts of missing participants are required to be
transferred to the other plan.
If the plan fiduciary is unable to locate an IRA provider willing
to accept the rollover distribution on behalf of the missing
participant, e.g., because of a very small account balance, two
alternative distribution methods are available. The missing
participant’s account balance may be transferred to either a
federally-insured interest-bearing bank account in the name of the
participant or to state unclaimed property funds in the state of the
missing participant’s last known address. Both of these methods will
result in immediate tax liability for the participant.
Conclusion
Plans that provide for mandatory distributions will need to begin
making automatic rollovers effective March 28, 2005. The delayed
effective date provides time for amending the plan document,
notifying participants, determining how rollovers will be invested
and selecting an IRA provider. A plan that does not currently
provide for mandatory distributions of more than $1,000 is not
subject to the new rules and does not need to take any action.
Plan fiduciaries must make reasonable efforts to locate lost
participants to fulfill their obligations under ERISA. The automatic
rollover safe harbor rules provide a solution for dealing with lost
participant account balances of $5,000 or less. These rules also
provide welcome relief for terminating defined contribution plans.
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