Department of Labor Issues Final Regulations Regarding "Automatic Rollovers" of "Mandatory Cash-Out" Distributions from Qualified Plans
The Internal Revenue Code (the "Code") permits tax-qualified retirement plans to distribute plan benefits with a present value of $5,000 or less (the "Cash-Out Limit") without receiving the participant's consent to such a distribution. These "mandatory cash-out" distributions are intended to allow plans to avoid the administrative burdens and costs associated with maintaining small plan balances for participants who terminated employment with the plan sponsor and are entitled to receive a distribution from the plan.
As part of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the Code was amended to provide that mandatory cash-out distributions in excess of $1,000 must be automatically rolled over to an individual retirement account (IRA) established on behalf of the participant by the plan sponsor. However, Congress recognized that the selection of a provider for the IRA accounts and the investment of the funds representing the mandatory cash-out distributions gave rise to fiduciary obligations under the Employee Retirement Income Security Act of 1974 ("ERISA"). Thus, EGTRRA provided that the mandatory cash-out provisions of the Code were not to become effective until the United States Department of Labor ("DOL") issued final regulations regarding the plan sponsor's fiduciary obligations with respect to the rollover of mandatory cash-out distributions to IRA accounts.
On September 28, 2004, the DOL issued its final regulations regarding the automatic rollover provisions of the Code which provide a safe harbor for plan sponsors which transfer mandatory cash-out distributions to IRA accounts. These regulations become effective March 28, 2005 such that the mandatory cash-out provisions of the Code will also become effective as of that date.
The final DOL regulations provide that a plan sponsor will be deemed to have satisfied its fiduciary duties under ERISA if certain specified conditions are met. These conditions are:
- The present value of the distribution does not exceed $5,000.
- The distribution must be made directly to an IRA.
- The plan sponsor must enter into a written agreement with the IRA provider which provides that (i) the funds shall be invested in an investment product designed to preserve principal and provide a reasonable rate of return offered by a state or federally regulated financial institution (i.e., certificates of deposit, money market funds, etc.), (ii) the fees and expenses of the IRA provider will not exceed the fees and expenses charged by such provider for other IRA accounts and (iii) the plan participant will have the independent right to enforce the terms of the agreement governing the IRA account after the funds representing the mandatory cash-out distribution are deposited in the IRA account.
- The plan sponsor must provide plan participants with a summary plan description (or a summary of material modification to the SPD) prior to making an automatic rollover of mandatory cash-out distributions to IRA accounts which shall contain (i) an explanation of the types of permitted investments for the funds representing the mandatory cash-out distributions, (ii) the name of the IRA provider and the fees and expenses which will be charged for maintaining the IRA accounts, (iii) a statement indicating how the fees and expenses associated with the IRA accounts will be paid and (iv) the name and contact information of the person acting on behalf of the plan who can provide for additional information regarding the automatic rollover provisions of the plan.
- The plan sponsor's selection of the IRA provider and the investment options for the funds representing the mandatory cash-out distributions must not violate the "prohibited transaction" provisions of ERISA (i.e., plan sponsor may not receive fees from the IRA provider).
On December 28, 2004, the Internal Revenue Service (IRS) issued Notice 2005-5 which provides additional guidance regarding various issues relating to the changes to the mandatory cash-out provisions under the Code and the implementation of the automatic rollover rules. The main issues addressed by Notice 2005-5 were as follows:
Plans Subject to the Automatic Rollover Rules
Notice 2005-5 provides that all tax-qualified plans under the Code (including both defined contribution and defined benefit plans), including governmental plans and church plans are subject to the automatic rollover rules. In addition, 403(b) arrangements and deferred compensation plans maintained by state or local governmental entities will also be subject to the automatic rollover rules under Notice 2005-5.
Types of Plan Distributions Subject to the Automatic Rollover Rules
Notice 2005-5 provides that the automatic rollover rules only apply to a "mandatory distribution" from a qualified plan that exceeds $1,000. Notice 2005-5 clarified that a "mandatory distribution" is an eligible rollover distribution that is made to a participant without the participant's consent before the participant attains the later of age 62 or the normal retirement age as set forth under the Plan. Thus, a required minimum distribution to a participant who is over age 70 1/2 which is not an eligible rollover distribution would not be subject to the automatic rollover rules. Notice 2005-5 also provides that distributions to a surviving spouse or a child under a qualified domestic relations order (QDRO) are not "mandatory distributions" for the purposes of the automatic rollover requirements of the Code. Notice 2005-5 further provides that the automatic rollover provisions do not apply when a distribution is deemed to occur when a participant defaults on the repayment of a plan loan.
Notice 2005-5 also clarified that the automatic rollover requirements will apply to any "mandatory distribution" that exceeds $1,000, regardless of the actual amount of the distribution. Thus, Notice 2005-5 specifically provides that the automatic rollover rules also will apply to a "mandatory distribution" which exceeds the Cash-Out Limit due to the inclusion of a participant's prior rollover contributions to the plan which are not taken into account in determining the participant's Cash-Out Limit.
Effective Date for Automatic Rollover Rules
Notice 2005-5 generally provides that the automatic rollover rules will go into effect for "mandatory distributions" which are made on or after March 28, 2005. However, Notice 2005-5 provides that governmental and church plans are not required to begin to comply with the automatic rollover rules until some time in 2006. In addition, Notice 2005-5 includes a limited transition rule for plans that are not able to implement sufficient administrative procedures (i.e., no contract to establish IRA accounts with an IRA provider) to comply with the automatic rollover rules by March 28, 2005. Under Notice 2005-5, these plans will not be deemed to be in violation of the automatic rollover rules so long as "mandatory distributions" to be made under the terms of the plan after March 28, 2005 are made no later than December 31, 2005.
Plan Amendment Requirements for Automatic Rollover Rules
Notice 2005-5 provides that qualified plans which are subject to the automatic rollover rules must be amended to include the provisions relating to the automatic rollover requirements by the end of the first plan year ending on or after March 28, 2005 (i.e., December 31, 2005 for calendar year plans). Notice 2005-5 provides a sample plan amendment which can be adopted by plan sponsors which will serve as a "good faith" plan amendment for the purposes of complying with the automatic rollover rules (although this sample amendment does not address many of the issues required by the DOL final regulations). Notice 2005-5 also provides that amending a qualified plan to eliminate mandatory cash-out distribution provisions will not violate the "anti-cutback" rules of the Code.
Based on the final DOL regulations and Notice 2005-5, employers which sponsor qualified plans that include mandatory cash-out distribution provisions will be required to amend their plan documents to be in compliance with the Code and to meet the conditions applicable to automatic rollovers of mandatory cash-out distributions which are set forth in the final DOL regulations. Although Notice 2005-5 provides for a limited transition period for complying with these automatic rollover rules (generally through December 31, 2005), we recommend that plan sponsors immediately begin to take certain steps relating to the automatic rollover requirements.
Although Notice 2005-5 contains a limited transition period, the automatic rollover rules will still apply to all mandatory cash out distributions made on or after March 28, 2005. Thus, plan sponsors should contact their plan administration firms to ensure that any small plan balances of terminated employees which are currently eligible for mandatory cash-out distributions are distributed prior to March 28, 2005 in order to avoid having the automatic rollover requirements apply to such distributions if they are made after March 28, 2005. In addition, plan sponsors should investigate whether the custodian of the plan's assets will also be willing to serve as an IRA provider for all future mandatory cash-out distributions and begin to negotiate the required contract for such services. Alternatively, a plan sponsor may wish to consider amending its qualified plan prior to the March 28, 2005 effective date to reduce the amount of the plan balances subject to the mandatory cash-out distribution provisions below the $1,000 threshold set forth in the Code. By so amending the plan, the plan sponsor will not be required to comply with the fiduciary safe harbor requirements set forth under the final DOL regulations relating to automatic rollovers of mandatory cash-out distributions.
If you have any questions regarding the new DOL regulations or Notice 2005-5, if you need help preparing a plan amendment and a Summary of Material Modification to the Summary Plan Description for your plan to address automatic rollovers of mandatory cash-out distributions or if you require assistance with any of the other plan administration issues relating to the automatic rollover requirements, please contact a member of our Labor and Employment Practice Group.
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