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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