• Automatic Rollovers are Coming - Are You Ready?
  • March 25, 2005 | Authors: James B. Bristol; Shannon Leigh Goff; Wm. Jay Harrelson; M. Sean Sullivan
  • Law Firm: Waller Lansden Dortch & Davis, LLP - Nashville Office
  • Effective March 28, 2005, all qualified retirement plans, such as pension plans, 401(k) plans and profit sharing plans, that have a mandatory cash-out distribution upon separation from employment provision cashing out accrued benefits of $5,000 or less, plus rollover contributions, must comply with the new automatic rollover rules. Under these new rules, if a participant fails to make an election as to whether he/she wants to take the distribution or roll it over into another plan or individual retirement account (IRA) and the plan forces the distribution, the plan administrator must distribute the money to a rollover IRA directly to an IRA provider selected by the plan sponsor if the distribution exceeds $1,000. Recently, the Internal Revenue Service (IRS) issued additional guidance for implementing the automatic rollover rules. This IRS guidance supplements the safe harbor rules issued earlier by the U.S. Department of Labor. The IRS guidance permits plan sponsors to delay such distributions until the end of the first plan year after March 28, 2005 (December 31, 2005 for calendar year plans) in order to set-up the administrative procedures, enter into the necessary agreements with IRA providers, and adopt the necessary plan amendment.

    Generally, plan sponsors have three options:

    1. Amend the plan to cash out only those account balances of $1,000 or less, including rollover contributions. This option eliminates the need for the plan sponsor to choose an IRA provider since amounts of $1,000 or less may still be paid directly to the participant in the absence of a rollover election.

    2. Amend the plan to eliminate the mandatory distribution provision entirely.

      We do not recommend these first two methods, because they will generally create more problems than they solve, such as more lost participants, as small account balances remain in the plan for long periods of time.

    3. Amend the plan document to automatically pay mandatory distributions of account balances greater than $1,000 to an IRA designated by the plan administrator unless the participant directs otherwise.

    Regardless of which method the plan sponsor adopts, it will need to prepare and distribute a Summary of Material Modifications (SMM) relating to the plan amendment to all participants. If the plan makes mandatory distributions of account balances greater than $1,000, then the SMM must (1) explain how the money will be invested and that the investment is designed to preserve principal and provide a reasonable rate of return, (2) describe what fees will be assessed and how the fees will be paid, (3) give the name, address and phone number of a plan contact for more information about the plan's automatic rollover provisions, and (4) disclose the name of the IRA provider.

    While not required by the law, plans may also provide for automatic rollovers for distributions less than $1,000. Although the dollar limit for mandatory cash-out distributions is $5,000, the actual account balance subject to the automatic rollover is not limited and may actually exceed $5,000 if the plan ignores rollover contributions for purposes of determining the balance for mandatory distributions.

    Generally, the IRA provider may be a bank, savings association, credit union, insurance company or mutual fund company. As part of the agreement with the IRA provider, the plan sponsor will need to select the initial investment option for all automatic rollovers. The investment option must be designed to preserve principal and provide a reasonable rate of return. Expenses and fees charged for the IRA cannot exceed the amount the IRA provider would charge for other IRAs that are not created by automatic rollovers.

    Plan sponsors who comply with the safe harbor rules will be deemed to have satisfied their fiduciary duties with respect to the selection of the IRA provider and the investment of the funds in connection with the automatic rollover.