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.
[top of page]
|