Retaining account balances for terminated participants in a qualified retirement plan often increases the plan’s administration expenses and fiduciary responsibility. Therefore, many plans include what is known as a “mandatory distribution” or “cash-out” provision to force the distribution of small account balances to terminated participants who fail or refuse to make an election either to receive the distribution in cash or roll it over to an Individual Retirement Account (IRA) or another qualified plan.
In order to preserve retirement savings for participants, effective March 28, 2005, new Department of Labor (DOL) regulations require that mandatory distributions between $1,000 and $5,000 be rolled over to an IRA on behalf of the participant rather than distributed in cash. These rules will also provide a means of rolling over small account balances for participants that cannot be located. The DOL has also extended reliance on these rules to lost participants in a terminating defined contribution plan.
This newsletter summarizes the new automatic rollover procedures and how they will ease the problem of making distributions to certain participants who cannot be found or refuse to make an election.
Background
One of the provisions included in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) is the requirement that plans providing for mandatory distributions must automatically roll over the distribution to an IRA on behalf of the participant, unless the participant affirmatively elects to receive the distribution in cash. This requirement is applicable if the vested account balance is between $1,000 and $5,000.
These rules were not to become effective until the DOL drafted safe harbor provisions that would protect plan fiduciaries from liability. On September 28, 2004 the DOL issued final regulations outlining the safe harbor rules which apply to mandatory distributions made on or after March 28, 2005.
Safe Harbor Requirements
Complying with the safe harbor requirements provides fiduciary protection for both the selection of an IRA provider and the investment of the funds. The safe harbor relief is contingent upon the plan fiduciary satisfying the following conditions:
Rollover Amount: An automatic rollover is required for mandatory distributions that are $5,000 or less but more than $1,000. The amount is determined as of the date the distribution is to be made. If the plan disregards amounts that the participant previously rolled over to the plan in determining whether the cash-out limit has been exceeded, it may also disregard these rollover contributions for automatic rollover purposes. If the plan so elects, the automatic rollover rules may also be applied to distributions of less than $1,000.
Individual Retirement Plan: The rollover must be made to a traditional IRA (not a Roth IRA) or an individual retirement annuity offered by a bank, insurance company or other financial institution.
Written Agreement: The plan fiduciary must enter into a written agreement with the IRA provider that addresses, among other things, the investment of the rollover funds and the fees and expenses to be charged to the account. One or more IRA providers may be selected. The plan fiduciary may rely on the IRA provider’s commitments set forth in the agreement and is not required to monitor the IRA provider’s compliance with the terms of the agreement once the rollover has occurred.
Permissible Investments: The rollover funds must be invested in a vehicle “designed to preserve principal, and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity,” such as money market funds, interest-bearing savings accounts, certificates of deposit or other “stable value products” offered by a bank, savings association, credit union, insurance company or mutual fund.
Fees and Expenses: The fees assessed against the IRA cannot exceed the amounts charged by the IRA provider for comparable IRAs established for rollover distributions that are not automatic rollovers.
Notice to Participants: All participants are required to receive notification of the automatic rollover provisions. This information must be included in the plan’s Summary Plan Description (SPD) or a Summary of Material Modifications (SMM).
Prohibited Transactions: The fiduciary may not engage in a prohibited transaction, such as a plan fiduciary receiving consideration from a financial institution in exchange for selecting that financial institution as the IRA provider. A class exemption permits a bank or other financial institution to select itself to receive automatic rollovers from its own qualified plan and utilize its own funds or investment products.
If the automatic rollover safe harbor requirements have been satisfied, the plan sponsor’s fiduciary responsibilities end immediately upon the transfer of the participant’s benefit to the IRA, and the distributed amount ceases to be a plan asset.
Lost Participants
In these times of high employee turnover, many retirement plans find themselves owing benefits to former employees whose whereabouts are unknown. This can be troublesome for ongoing plans since, in many cases, the administrative costs are high related to the participants’ account balances. If the plan permits mandatory distributions and the distribution is $5,000 or less, the new automatic rollover procedures provide a method of distributing the vested account balance from the plan (mandatory distributions from an ongoing plan are not permitted if the vested balance exceeds $5,000).
Welcome Relief For Terminating Defined Contribution Plans
A terminated defined contribution plan is required to distribute all plan assets as soon as administratively feasible after the date of plan termination. Participants are required to be notified of the plan termination and given a choice of receiving a distribution or having it directly rolled over to an IRA or another qualified plan. When participants are lost or do not respond to written notices, plan administrators often are faced with an array of fiduciary issues and are unable to effectively wind-up the plan’s financial affairs.
Recognizing this problem, the DOL released Field Assistance Bulletin 2004-02 on September 30, 2004 outlining the fiduciary obligations for a terminated defined contribution plan, including mandatory search methods for locating a missing participant and steps for distributing an account balance when efforts to locate the missing participant fail. The DOL guidance for terminated defined contribution plans is effective immediately.
Mandatory Search Methods
The DOL requires that every plan must employ the following search methods regardless of the size of the missing participant’s account balance. The plan should retain documentation to prove that attempts to contact the participant were unsuccessful. Reasonable expenses incurred attempting to locate missing participants may be charged to the participant’s account.
Use Certified Mail: Sending certified mail to the participant’s last known address can easily ascertain whether the participant can be located in order to distribute benefits.
Check Related Plan Records: Determine whether the employer’s records or the records of another plan maintained by the employer, such as a group health plan, has a more current address.
Check With Designated Plan Beneficiary: Attempt to identify and contact any individual that the missing participant has designated as a beneficiary.
Use a Letter-Forwarding Service: Use either the IRS or the Social Security Administration (SSA) letter-forwarding program in an attempt to locate missing participants. A Social Security number is required to use these programs. In general, both the IRS and SSA search their records for the most recent address of the participant and forward a letter from the plan fiduciary to the participant. The IRS and SSA cannot provide the plan with any information concerning the results of their efforts. Hopefully, the letter from the plan will cause the participant to contact the plan directly.
Other Search Options
If none of the four mandatory search methods is successful in locating the participant, the plan fiduciary needs to consider whether, under the facts and circumstances, it would be prudent to use other methods, such as Internet search tools, commercial locator services and credit reporting agencies. If the cost of using these services will be charged to the participant’s account, the plan fiduciary will need to consider the size of the participant’s account balance in relation to the fees that would be incurred when deciding whether to use any of these alternatives.
Distribution Options
If the fiduciary is unable to obtain a participant’s election concerning the distribution of benefits or a prudent search does not locate a missing participant, the plan may proceed with the distribution of the participant’s account balance. The preferred method is to roll the participant’s account balance into an IRA, and fiduciaries may rely on the automatic rollover safe harbor rules described above. In general, if all of the safe harbor rules are satisfied, the amount rolled over may exceed $5,000, unless the plan offers an annuity option or the employer, or a related company, sponsors another defined contribution plan.
If a plan offers an annuity option, such as required in a money purchase pension plan, distributions in excess of $5,000 must be in the form of an annuity contract or irrevocable insurance commitment. If the employer maintains another defined contribution plan (other than an ESOP), accounts of missing participants are required to be transferred to the other plan.
If the plan fiduciary is unable to locate an IRA provider willing to accept the rollover distribution on behalf of the missing participant, e.g., because of a very small account balance, two alternative distribution methods are available. The missing participant’s account balance may be transferred to either a federally-insured interest-bearing bank account in the name of the participant or to state unclaimed property funds in the state of the missing participant’s last known address. Both of these methods will result in immediate tax liability for the participant.
Conclusion
Plans that provide for mandatory distributions will need to begin making automatic rollovers effective March 28, 2005. The delayed effective date provides time for amending the plan document, notifying participants, determining how rollovers will be invested and selecting an IRA provider. A plan that does not currently provide for mandatory distributions of more than $1,000 is not subject to the new rules and does not need to take any action.
Plan fiduciaries must make reasonable efforts to locate lost participants to fulfill their obligations under ERISA. The automatic rollover safe harbor rules provide a solution for dealing with lost participant account balances of $5,000 or less. These rules also provide welcome relief for terminating defined contribution plans.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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