GT Alert

Automatic Rollover Requirements

March 2005

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The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) imposed new requirements on qualified retirement plans that provide for “mandatory distributions” of amounts equal to $5,000 or less. EGTRRA requires that mandatory cash-outs of amounts between $1,000 and $5,000 be automatically rolled over to an individual retirement plan (that is, an individual retirement account or individual retirement annuity), unless the participant elects otherwise. This requirement is effective for distributions made on and after March 28, 2005.

The new requirements call for immediate action by most plan sponsors. Administrative procedures will need to be modified without delay if compliance is to be maintained. For example, mandatory distributions between $1,000 and $5,000 which would previously have been sent to a participant as a matter of course, must not be mailed out to any participant who has not made an affirmative election to receive it.

Background

On September 28, 2004, the DOL published final safe harbor regulations effectuating the changes made by EGTRRA to automatic rollovers of certain mandatory distributions. On December 28, 2004, the IRS issued Notice 2005-5 providing guidance relating to such automatic rollovers. This Alert contains a brief description of the requirements contained in both the DOL and the IRS guidance as well as a discussion of the actions plan sponsors must take to maintain plan compliance.

A mandatory distribution (or cash-out) is an immediate distribution of amounts of $5,000 or less made due to an employee’s termination of service and before normal retirement age (or age 62, if earlier) and which does not, under the terms of the plan, require consent of the participant or spouse. Note that there is no requirement that a plan provide for mandatory cash-out of small benefits. However, if a plan includes such a provision, it becomes subject to the new automatic rollover rules for mandatory distributions greater than $1,000.

Department of Labor Regulations

The new requirements have generated a great deal of concern since plan sponsors, in most cases, will be taking on the fiduciary duties of choosing a default IRA provider and an initial investment vehicle for the automatic rollover amounts. In this regard, final DOL regulations establish a fiduciary safe harbor providing relief to plan fiduciaries in connection with automatic rollovers of mandatory distributions. Under the final DOL regulations, if the conditions of the safe harbor are satisfied, the plan fiduciary will be deemed to have fulfilled his or her fiduciary duties with respect to both: (a) the selection of the individual retirement plan provider and (b) the selection of the investments for such plan.

The standards for the fulfillment of fiduciary duties set forth in the regulations apply solely in determining compliance with the safe harbor and are dependent upon a fiduciary satisfying the conditions set forth in the regulations. They are not intended to represent the exclusive means for a fiduciary to satisfy his or her ERISA duties with respect to automatic rollovers. For a summary of these provisions, see Appendix A included in this Alert.

IRS Guidance

The IRS provided guidance on automatic rollovers in its Notice 2005-5, released on December 28, 2004. A summary of the requirements provided in IRS Notice 2005-5 and the IRS sample amendment is provided in Appendix B included in this Alert.

Important Considerations and Required Action

By March 28, plan sponsors and administrators need to consider the available options, decide on modifications to plan design and discontinue automatic cash-outs exceeding $1,000. Alternatives to consider and required actions include the following:

Implement the new automatic rollover – Plan sponsors who choose to implement the automatic rollover provisions must do the following:

• Decide whether or not to lower the threshold to provide for automatic rollover of amounts of $1,000 or less. This will rid the plan of the extra administrative burden of retaining such small amounts. For defined benefit plans, this may reduce the amount of PBGC premiums that must be paid. For defined contribution plans, this could eliminate record keeping costs for accounts that will now be rolled over.

• Amend the plan – by December 31, 2005 for calendar year plans (See IRS sample amendment in Appendix B below)

• Select an IRA provider
• Select the initial investment vehicle(s)
• Modify plan distribution forms
• Prepare all communications to participants (that is, by SMM or revised SPD as required by DOL and participant notice required by IRS – note that IRS notice may be incorporated into 402(f) notice currently used or provided as a separate notification)
• Modification of procedures currently utilized for cashing out of mandatory distributions (After March 27, plans can no longer send involuntary mandatory distribution checks in excess of $1,000 to participants who have not yet reached normal retirement age under the plan (or, if later, age 62)).

If the choice is made to implement the automatic rollover provisions, it is advisable to take advantage of the DOL’s safe harbor provisions in order to protect plan fiduciaries from liability should the IRA investment results prove unfavorable.

Avoid the new automatic rollover requirements

• Plan sponsors may also choose to take action to avoid the automatic rollover requirements. Basically, this can be accomplished in one of two ways:
• Amend the plan to eliminate the plan’s mandatory distribution provisions totally OR
• Amend the plan to limit involuntary cash-outs prior to a participant’s normal retirement age to $1,000 or less. Benefit amounts between $1,000 and the plan’s involuntary cash-out threshold would remain in the trust (plan) until such time as the participant elects a voluntary distribution, attains normal retirement age or becomes subject to the minimum distribution requirements.
• Rollover amounts ARE INCLUDED in determining if the benefit is less than $1,000 even though rollover amounts are not taken into account for determining whether a mandatory distribution is permitted.
• For calendar year plans, amend by December 31, 2005. IRS did not provide a sample amendment.

Required action – Whether automatic rollover provisions are to be implemented or not, the following actions are necessary:

• The manner in which retirement plan distributions are processed must be immediately changed to ensure that no checks of amounts in excess of $1,000 are mailed after March 27 to participants who have not affirmatively elected to receive them.
• Benefit distribution packages that are currently being mailed must be immediately modified. For example an addendum may be added to current distribution packages to direct participants to ignore statements indicating that a benefit check will be mailed to them if they take no action. The addendum could also be used to advise participants to expect further information at a later date if they do not respond.

Conclusion

As you can see, the new requirements have left plan sponsors with many issues to consider and important decisions to be made. We recognize that this is a lot of information to digest all at once. Please give us a call as soon as possible to discuss any questions or concerns you may have. Keep in mind that some decisions will need to be made before March 28.

Appendix A

Summary of Provisions of DOL Safe Harbor

• Amount of Mandatory Distributions – The amount of the distribution may not exceed $5,000 (plus amounts attributable to prior rollover contributions). Additionally, it is worth noting that, although the EGTRRA provisions addressed cash-outs between $1,000 and $5,000, the final DOL regulations extended the fiduciary relief to all mandatory cash-outs of $5,000 or less.

• Rollover Distribution to an Individual Retirement Plan – The plan fiduciary must open an individual retirement plan in the participant’s name. The IRA provider is required to be a state or federally regulated financial institution such as a bank, an insured credit union, an insurance company or an investment company registered under the Investment Company Act of 1940. The distribution must be rolled over to an individual retirement plan under such institution. Plan sponsors may select more than one provider to receive automatic rollovers.

• The plan fiduciary must enter into a written agreement with the IRA provider, including provision for the rolled-over funds to be invested in an investment product designed to preserve principal and provide a reasonable rate of return. The written agreement must address fees and related expenses. The plan fiduciary is not required to monitor the provider’s compliance with the terms of the agreements after the rollover occurs.
• The investment product must be designed to minimize risk and maintain liquidity. Acceptable investments include: money market funds, interest-bearing savings accounts, certificates of deposit and “stable value” products that guarantee liquidity.
• Fees and expenses must be reasonable and should be comparable to those charged by the IRA provider for comparable individual retirement plans established for reasons other than receipt of automatic rollovers.
• The participant on whose behalf the automatic rollover has been made must ultimately have the right to enforce the terms of the agreement establishing the individual retirement plan with regard to his rolled over funds.

• Participants must be provided with information – Plan sponsors must furnish participants with a summary plan description or a summary of material modifications describing the plans automatic rollover procedures including: the nature of the investment product; the allocation of fees and expenses between IRA holder, distributing plan and plan sponsor; and information about who to contact if further information is desired.

• Safe harbor relief is conditioned on the plan fiduciary not engaging in any prohibited transaction in connection with the selection of IRA provider or investments. In connection with this issue, the DOL released a class exemption allowing certain plan sponsors to select their own services and products for rollovers from plans they maintain for their own employees.

Appendix B

Summary of Provisions of IRS Notice 2005-5

• Range of plans affected by IRS guidance – The automatic rollover requirements set forth in IRS Notice 2005-5 apply to all qualified plans, and other tax-favored plans including single-employer, multiemployer, government and non-electing church plans containing mandatory distribution provisions. This includes 401(a), 401(k), 403(b), church plans and governmental plans including governmental 457(b) plans. However, the deadline for implementing these requirements is extended for both governmental and non-electing church plans.

• Required Plan Amendment – Plans containing mandatory distribution provisions must, generally, be amended to comply with the new automatic rollover requirements by the last day of the plan year ending on or after March 28, 2005. This could be as early as March 31, 2005 for plans with fiscal years ending March 31.

In this regard, the IRS notice contains a sample amendment which will be considered a “good faith” amendment. This sample amendment is for employers who want to amend their plan to accommodate the automatic rollover of mandatory distributions of over $1,000.

• Sample amendment provided in IRS Notice 2005-5 – Following is the sample “good faith” amendment provided by the IRS to implement the new IRA rollover rules:

Section 401(a)(31)(B) Sample Amendment
“In the event of a mandatory distribution greater than $1,000 in accordance with the provisions of section _____, if the participant does not elect to have such distribution paid directly to an eligible retirement plan specified by the participant in a direct rollover or to receive the distribution directly in accordance with section(s) _____, then the plan administrator will pay the distribution in a direct rollover to an individual retirement plan designated by the plan administrator.”

• Transition Relief – Although the automatic rollover requirements apply to mandatory distributions made on or after March 28, 2005, the IRS notice provides transition relief for plan sponsors who need more time to establish and implement the necessary administrative procedures. In the event that a plan sponsor does not process automatic rollovers of mandatory distributions on or after March 28, 2005 due to lack of sufficient administrative procedures, the plan will not be treated as failing to operate in accordance with its terms provided, the eligible mandatory distributions are made on or before December 31, 2005.

• Required Participant Notices – Prior to making a mandatory distribution, the plan administrator must provide each participant individually with a written notice stating that, absent his or her affirmative election, the distribution will be automatically rolled over to an IRA. This notice is required to identify the trustee or issuer of the individual retirement plan. The IRS has specified that this notice may be provided as part of the rollover notice (already required by IRC Section 402(f) to be given to participants receiving distributions). This notice is required in addition to the general explanation required by the DOL in order to take advantage of the safe harbor relief (Appendix A, above). This notice may be sent by electronic medium.

• Miscellaneous

• The IRS notice makes clear that a plan amendment to eliminate mandatory distributions may be made without violating the anti-cutback provisions of the Internal Revenue Code.
• An eligible rollover distribution in the form of a plan loan offset amount is not subject to the automatic rollover provisions.
• Distribution to a surviving spouse or alternate payee is not subject to the automatic rollover rules.

This Alert was written by Terry Moore, Director of Employee Benefits Services and Marlene Grossman, Assistant Director of Employee Benefits Services in the New York office. Please contact Ms. Moore at (212) 801-6534, Ms. Grossman at (212) 801-9285 or your Greenberg Traurig liaison if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig

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