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Automatic Rollover of Distributions Between $1,000 and $5,000...

 Law Change Requires Prompt Attention and Action by Employers in 2005

The IRS and DOL have recently issued guidance on the implementation of the Automatic Rollover requirement that was enacted by EGTRRA.  This requirement means plans that cash out terminated participants who are due a benefit between $1,000 and $5,000, without their consent (the “mandatory cash out” rule), now have to consider how to administer this feature after March 28, 2005. 

This “mandatory cash out” rule enables plans to dispose of small accounts, thus reducing the administrative expense of maintaining these accounts.  These distributions are sent to the Participant in cash minus the 20% federal income tax withholding.

Effective March 28, 2005, distributions that are subject to this “mandatory cash out” rule may still be made without the Participant's consent, but if the Participant does not affirmatively elect a distribution option, the plan must transfer the distribution to an IRA.  The Employer that sponsors the Plan must select an IRA provider and enter into an agreement with that provider for these types of IRA's.  Certain default investments are used, and the Employer is relieved of any fiduciary responsibility for the IRA after the funds are transferred to it.

 Plans have two basic choices as to how to address this rule change:

Amend the plan to reduce the “mandatory cash out” rule to apply only to benefits of $1,000 or less.  This will enable plans to avoid having to enter into an “Automatic Rollover” agreement with an IRA provider.

Amend the plan to adopt the new Automatic Rollover rule.  This requires that “mandatory cash out” distributions of between $1,000 and $5,000 will be transferred to an IRA unless the Participant affirmatively elects otherwise.

• You can also amend your plan to apply the new Automatic Rollover rule to all distributions of $5,000 or less.  However, it may be difficult to find IRA providers who are willing to set up IRA accounts for amounts of under $1,000. 

Action you must take:

 If you decide to reduce the cash out threshold to $1,000 you will need to do the following:

a)      Amend the Plan.  This amendment must be adopted by the end of your plan year that ends after March 28, 2005.  That means if your plan year ends on March 31, the amendment must be adopted by March 31, 2005, if it ends April 30, the amendment must be adopted by April 30, 2005, etc.  Calendar year plans have until December 31, 2005.
b)      Revise the Summary Plan Description (SPD).  Active Participants must be notified through the SPD or a Summary of Material Modifications as a supplement to the SPD.

OR

If you decide to amend your plan to adopt the new Automatic Rollover rule for amounts between $1,000 and $5,000, you will need to do the following:

a)      Select an IRA custodian that will accept Automatic Rollovers.  This is a fiduciary decision and may take some time.  It should be done in accordance with an evaluation and selection process that in all likelihood will involve your investment professional. The investment vehicle to be used should also be chosen at this time. Investment providers may offer this service to their clients who are using their investment product.  As part of the selection process you may very well decide to use your current investment provider as your default IRA provider.

b)      Amend the Plan.  This amendment must be adopted by the end of the plan year that ends after March 28. This amendment must be adopted by the end of your plan year that ends after March 28, 2005.  That means if your plan year ends on March 31, the amendment must be adopted by March 31, 2005, if it ends April 30, the amendment must be adopted by April 30, 2005, etc. For calendar year plans this means December 31, 2005

c)      Notify the Participants.  Terminated Participants must receive a Notice that explains the automatic rollover rule, that identifies the default IRA custodian and investment vehicle, and the fees that will be charged and how they will be paid (usually they will be deducted from the IRA).

d)      Revise the Summary Plan Description (SPD).  Active Participants must be notified through the SPD or a Summary of Material Modifications as a supplement to the SPD. 

There are advantages and disadvantages to each of these choices.  The default rollover option is complicated, but it may be beneficial for plans that have a lot of distributions in a year and have difficulty locating or getting responses from participants.  For Plans that have very few distributions, if the distributions are usually under $1,000, or if nonresponsive participants are not usually a problem, reducing the cash out threshold to $1,000 may be the easier solution. 

Reducing the cash out threshold to $1,000 is the amendment we are presenting to our clients as a “default” since we believe that most of our clients' plans will not benefit from the additional administrative burden of the default rollover procedures.  TSC is in the process now of sending out these amendments.  We will incorporate the amendment into any other amendments that we have outstanding for a plan at this time.

If you have questions about this, please call your contact at TSC.  If you decide you prefer to adopt the Automatic Rollover amendment, the amendment itself needs to be adopted by the end of your plan year that ends after March 28, but as to the other items you have until the end of the year to get that worked out.