The IRS has issued guidance on automatic rollovers of cash-out amounts. A model amendment is included.

Automatic Rollover Implementation Guidance Issued

The IRS released additional written guidance needed to implement the automatic rollover rules on December 28, 2004. The guidance (IRS Notice 2005-5) supplements the regulations issued in September by the Department of Labor that established a safe-harbor for automatic rollovers of mandatory distributions. It was provided in the form of 16 questions and answers, and it included a suggested model “good faith” amendment that may be adopted by both pre-approved and individually designed retirement plans. The automatic rollover rules apply to mandatory cash outs of eligible rollover distributions of $1,000 or more that occur on or after March 28, 2005. The retirement plans that must comply with the new rules include qualified retirement plans, 403(b) arrangements under Title 1 of ERISA, government-sponsored plans (including 457(b) plans), and church plans that allow mandatory distributions. Generally, these plans must be amended by the end of the first plan year ending on or after March 28, 2005. However, certain governmental and church plans have been provided with a delayed adoption deadline that will permit adoption during 2006.

MHC Comment: The amendment adoption deadline may cause logistical problems for fiscal year plans with a year ending on or after March 28, 2005, because such plans with mandatory distribution provisions will have to adopt the model amendment on a date earlier than December 31, 2005, the deadline for calendar year plans.

According to Notice 2005-5, a distribution is mandatory if it is made without the plan participant’s consent and it is made before the participant attains the later of age 62 or the plan’s normal retirement age. Distributions to a surviving spouse or to an alternative payee and distributions of a plan loan offset are not subject to the automatic rollover rules. The automatic rollover provisions of the regulation will apply to all mandatory distributions of $1,000 or more (regardless of the $5,000 statutory upper limit on mandatory cash outs). The automatic rollover rules may become applicable to distribution amounts in excess of $5,000 in the event of plan termination or if participant rollovers cause the value of the participant’s account to exceed $5,000.

MHC Comment: Nothing in the guidance prohibits the application to these rules to amounts less than $1,000. For administrative consistency and ease, if the plan provides for mandatory cash outs of amounts, we are recommending application of the automatic rollover provisions for all amounts greater than $200.

Compliance with the new rules is demonstrated by providing the affected participant a written notice, which may be a separate notice or included as part of the §402(f) notice, that unless the participant requests either a direct rollover or a cash payment, an automatic rollover to an employer-established IRA will occur. (The IRS did not indicate whether it will release an updated 402(f) notice in the future.) Such notice may be mailed to the participant’s last known address (or provided electronically pursuant to A-5 of Treas. Reg. §402(f)-1). “Service” will be considered completed even if the US Postal Service returns the notice as undeliverable.

Notice 2005-5 provides an “out” for plans that do not wish to comply with the automatic rollover provisions. The IRS provided a reminder in its notice that mandatory distribution provisions are not a protected benefit, and they may be eliminated without violating the anti-cutback rules.

MHC Comment: Although mandatory distribution provisions were generally adopted to promote administrative convenience and potentially reduce costs associated in administering small accounts left by terminated participants, the recent IRS and DOL guidance permitting the charging of reasonable administrative fees to such participants may offset any inconvenience associated with retaining such accounts in the plan.

Steve Oberndorf

For Notice 2005-5, click here.