Automatic Rollovers of Certain Mandatory Distributions Executive Summary; Action Date Before March 28, 2005

Automatic Rollovers of Certain Mandatory Distributions Executive Summary; Action Date Before March 28, 2005

February 2005
By Deborah L. Grace A. Current Law – A retirement plan may cashout a terminated participant, without the participant's consent, if the account balance is $5,000 or less, and the plan has given the participant 30-days notice of his or her right to rollover the distribution into an IRA or another employer's retirement plan. Many plan administrators direct their trustees to issue a check payable to the participant if the participant does not return the paperwork after 30 days. B. New Law - Effective March 28, 2005, if the value of a proposed cashout distribution is more than $1,000 and less than $5,000, and the participant does not respond to the plan's distribution letter, and the plan document requires distribution, the trustee must transfer the distribution to an IRA established for the benefit of the terminated participant. The trustee can no longer mail an un-requested check to the participant. Department of Labor Guidance - To reduce plan administrators' concerns about potential fiduciary liability in establishing IRA's for participants, the DOL has established a safe harbor. If the administrator follows the safe harbor steps when designating an institution to receive the automatic rollover and the initial investment choice for the rolled over funds, then the plan administrator's actions satisfy the fiduciary responsibility requirements of ERISA Section 404(a). Section D, below contains more detail on these requirements. IRS Guidance – Plan administrators that want to continue after March 28th cashing out distributions that are greater than $1,000 and less than $5,000 must have new procedures in place prior to processing distributions to which participants do not consent. In addition, they must make any necessary corresponding amendment to their plans by the end of the first plan year that ends after March 28, 2005 (for example, December 31, 2005 for a calendar year plan; June 30, 2005 for a plan that has a plan year ending June 30). C. Action Steps to Take before March 28, 2005 1. Assess Current Documents and Practices – ERISA requires that Plan Administrators administer their plans in accordance with their terms. You should determine the following: a. How have you been treating terminated employees' accounts that are less than $5,000? b. What does the Plan document and Summary Plan Description provide about these accounts? Most plans provide for forced cashout distributions. Is the language consistent with the plan administrator's actions? Does it imply that forced cashouts will be made, but none are? c. What does the Plan distribution paperwork provide about cashouts? 2. Determine what your practice will be on and after March 28, 2005 - Depending on the plan's language, your choices are either to follow the new rules or amend the plan so that distributions are only made if the participant returns a signed distribution form. Both choices require paperwork, and have their pros and cons, as explained below. a. Follow new rule – To implement the new rule, the plan administrator needs to identify the financial institution at which the IRA will be opened (check with your current record keeper or financial advisor), sign an agreement with the IRA sponsor, adopt new plan procedures reflecting these rules, and advise participants of the Plan's continuing policy of cashing out small benefits, including establishing IRA's for those who do not respond to the distribution letter. The IRS guidance indicates that if the plan administrator/trustee is not able as of March 28, 2005 to implement the automatic rollover provisions, it may do so at any time prior to the end of the 2005 calendar year. So, if the identified IRA provider cannot start automatic rollovers until the middle of 2005, the Plan Administrator would hold benefit distributions for which it does not have consent until it could comply with the new rules. The IRS would find this deviation from the plan language as acceptable, so long as the cashouts are done by the end of the 2005 calendar year. b. Only make distribution if a participant consents – To avoid the automatic rollover rules, the plan administrator would have to modify its procedures so that distributions are not made for accounts that are more than $1,000 and less than $5,000 unless the participant consents. If this course of action is chosen, the Plan must be amended to reflect this new procedure and the amendment must be in place by the end of the first plan year that ends after March 28, 2005. Also, the Summary Plan Description and the distribution forms may have to be updated. In making this decision, the Plan Administrator should weigh the fees charged by the recordkeeper (is there a per participant fee, including anyone with an account balance; are fees based on total plan assets?) and the administrator's ability to transfer to a third party the responsibility of keeping track of former employees. 3. Finish the Paperwork – Once the Plan Administrator has determined how the Plan will treat terminated participants' account balances that are between $1,000 and $5,000, the Plan Administrator should adopt any necessary plan amendments, modify the summary plan description or issue a statement of material modification to the summary, revise distribution forms, and enter into any necessary agreements with an IRA provider. D. Additional Technical Information Requirements for Reliance on DOL Safe Harbor. To qualify for the safe harbor, the Plan Administrator must satisfy the following conditions. 1. The amount of the nonforfeitable accrued benefit that is being distributed cannot exceed $5,000. In determining if the $5,000 limit has been exceeded, the amounts that a participant rolled into the Plan from another employer's plan can be disregarded, if the Plan normally disregards these amounts when determining if a cashout should be made. 2. The cashout must be directed to an individual retirement plan, as defined in the Tax Code, which is an Individual Retirement Account (IRA) or an Individual Retirement annuity. 3. The Plan Administrator and the Individual Retirement Plan must have a written agreement that specifically addresses – a. the investment of rolled-over funds - must be invested in products that are designed to preserve principal and provide a reasonable rate of return; the investment product - must seek to maintain, over the term of the investment, the dollar value that was initially invested and the products must be offered by a state or federally regulated financial institution such as a bank or savings association (i.e. money market funds, and interest-bearing saving accounts or certificates of deposit;) b. fees and expenses of the Individual retirement plan cannot exceed those charged by the individual retirement plan for comparable type accounts. c. The plan participant must be able to enforce the terms of the agreement against the Individual Retirement Plan; The preamble to the regulations makes it clear that the Plan administrator can rely on the commitment of the Individual Retirement Plan, and does not need to monitor the provider's compliance with the terms of the agreement – once the funds are rolled over. 4. Notice to Participants. Prior to an automatic rollover, participants must be furnished a SPD or a summary of material modifications (SMM) that includes an explanation of - the nature of the investment product in which the cashout will be invested, and - how fees and expenses attendant to the individual retirement plan will be allocated (i.e. borne by the account holder alone or shared with the plan sponsor and the account holder). - the fact that the account can be transferred by the participant once it is automatically rolled over; and - the plan contact person for future information. 5. No Prohibited Transaction. The Plan sponsor cannot be engaging in a prohibited transaction when it selects the individual retirement plan provided. DOL has published a final class exemption permitting a bank or other financial institution to select itself or an affiliate as the individual retirement plan provider. Procedures Required by the IRS A Plan Administrator must provide notice to the participant that the automatic rollover will be made if the participant does not affirmatively make another choice. The notice must identify the trustee or issuer of the individual retirement plan. Plan administrators may delay making distributions until they have an agreement in place with the individual retirement plan administrator, and the appropriate notices drafted.