The DOL has issued final rules (69 Federal Register 58018, September 28, 2004) authorizing the automatic rollover of involuntary cash-out amounts of less than $5,000. Under the final rules, amounts under $1,000 may also be automatically rolled. The final rules become effective 6 months after the September 28th publication date, which is March 28, 2005.

The DOL final rule contains changes to the six safe harbor requirements that were first itemized in the proposed regulations. In fact, there are now only 5 requirements, which, if satisfied, will permit a qualified plan sponsor to rollover a distributable amount directly to an IRA on behalf of a missing or non-responding participant. Highlights of the final rules follow.

Safe harbor relief is dependent on the fiduciary satisfying the following five conditions:

Distribution Amount Range (Section (c)(1) of the Final Regs.)
Cash-out distributions must be less than or equal to $5,000. The amounts considered are the present value of the vested accrued benefit (account balance for defined contribution plans).

The final rule adds the provision to permit (though not require) amounts of $1,000 or less to also be automatically rolled over. This will make it easier for the administration of the cash-out rules.

McKay Hochman Comment: If the total amount distributable for the entire year is less than the $200 mandatory withholding threshold, the amount should probably be paid directly to the participant, if the participant can be located.

The present value of the nonforfeitable accrued benefit is determined as of the date of distribution. Thus, for example, if the participant terminates employment with $5,600, but the value declines to $4,700, the sponsor may cash-out the participant. Code Section 411(a)(11), 401(a)(31)(B)(i).

Rollover Must Be to an IRA (Section (c)(2) of the Final Regs.)
The amount must be rolled into an Individual Retirement Account as described in 408(a) or 408(b), i.e. a traditional IRA Account or a traditional IRA Annuity. The IRA must have a bank or an IRS approved non-bank Custodian/Trustee/Issuer.

Permitted Investments (Section (c)(3) of the Final Regs.)
The DOL has provided an investment safe harbor that will allow the plan to establish IRAs for involuntary cash-out participants without the assumption of fiduciary liability for future investment results. Under the safe harbor, the plan fiduciaries may enter into a written agreement with an IRA account or annuity provider, the terms of which provide that:

MHCO Comment: This provision is designed to meet the DOL's goal of preserving the principal amount while providing a reasonable rate of return and maintaining liquidity. The regulations provide the examples of permissible investment vehicles, such as a money market mutual fund, a stable value fund and Certificates of Deposit. The DOL states that if the safe harbor rules are followed, the fiduciary responsibility of the plan fiduciary ends once the funds are deposited to the IRA.

Fees and Expenses Issue
The DOL wants to strike a balance between the fees and expenses of the marketplace environment with the need to preserve the participant's principal for retirement use.

Examples of fees and expenses covered by the regulation include: establishment charges, maintenance fees, investment expenses, termination costs and surrender charges.

The final regulations establish the following guidelines with respect to permissible fees and expenses:

Disclosure Requirements (Section (c)(4) of the Final Regs.)
The regulation requires that the SMM/SPD provide the following information:

McKay Hochman Comment: In addition, the 402(f) notice and related administrative forms should be modified accordingly to cross-reference the SMM/SPD. Also, prototype plans are already required to have a contact person specified to answer questions about the qualified status of the plan, this could be the same contact required by these regulations.

Prohibited Transactions (Section (c)(5) of the Final Regs.)
The plan fiduciary may not engage in a prohibited transaction when selecting the IRA provider. However, the DOL has published a proposed class exemption by which:

The DOL simultaneously issued PTE 2004-16 to implement this exemption.

Mandatory Distribution of Amounts of $1,000 or Less
The DOL added Section (d) to the final regulations to authorize the extension of automatic rollover authority to amounts under $1,000. Considering the fee structure of IRA provider institutions, a question arises as to what is the minimum account balance that vendors of the IRAs will accept for these accounts. See our comment above on amounts under $200.

OTHER ISSUES

Participant Loans
Whether the amount of an outstanding participant loan would be a portion of the vested accrued benefit in calculating the $5,000 was referred by the DOL to the IRS and Treasury for consideration.

Customer Identification and Verification (CIP) requirements of the Patriots Act.
The final regulations state that the CIP only will be required at the time the participant or beneficiary first contacts the IRA provider. Thus, an automatic rollover may be made without violating the requirement that the CIP be obtained at the time the IRA is established. FAQs on this issue may be found at page 9904 of the Federal Register of March 2, 2004.

ERISA Section 404(c)(3)
The DOL final regulations confirm that for purposes of 404(c)(3), the DOL views the participant as exercising control over the assets of the IRA as soon as the assets are deposited to the IRA. Thus, the plan fiduciary is permitted to rollover cashed-out amounts without retaining liability for future investment results.

Missing Participants
This issue is beyond the scope of this safe harbor initiative. However, the DOL issued separate guidance on missing participants. Click here for the DOL guidance on this subject.

Beneficiary Designations
According to the final regulations, the beneficiary designation under the qualified retirement plan would cease to control who is the beneficiary under the IRA upon the deposit of the cashed-out amount to the IRA. The IRA provider may apply its own default provisions under the terms of the IRA until the IRA account owner affirmatively completes a beneficiary designation under the terms of the IRA.

Safe Harbor Rules Are Not the Only Way
The regulation states that the standards set forth in the regulations are set forth for the purpose of providing a safe harbor and that such standards are not intended to be the exclusive means by which a fiduciary might satisfy his or her duties with respect to automatic rollovers of mandatory distributions described in Section 401(a)(31(B).

MHCO Comment: Though the final regulations indicate that an alternative method may be used to achieve the automatic rollover of a cash-out amount to an IRA, there is no other method provided and, thus, any other method is done at a risk which does not afford the comfort of the safe harbor.