The Department of Labor (DOL) released proposed regulations relating to automatic rollovers of certain cash-out distributions from qualified retirement plans to IRAs. As part of EGTRRA, a provision was added to the IRC to require that automatic cash-outs of more than $1,000 be automatically rolled over to an IRA if the distributee fails to make an election to receive the distribution or have it rolled-over to another qualifying vehicle. This provision of EGTRRA will only become effective 60 days after the DOL finalizes these regulations.

The proposed regulations set forth a safe-harbor that will protect fiduciaries who must select the IRA and invest the funds. Satisfaction of the safe-harbor is not required, but it is likely that most fiduciaries will want to follow the safe-harbors in order to ensure that they have protection. In general, the six (6) conditions that a fiduciary must satisfy in order to fall within the safe-harbor are:

1. The distribution must be one covered by the automatic IRA rollover rules. This means the plan must provide for automatic cash-outs and the cash-out amount must be more than $1,000 and equal to or less than $5,000. If provided in the plan, rollovers received by the distributing plan may be excluded in determining whether the $1,000 and $5,000 thresholds have been satisfied. Thus, the dollar amount being automatically rolled over into an IRA could actually exceed $5,000 (e.g., when the excess is due to rollovers that had previously been made into the distributing plan).
   
   
2. The automatic rollover must be to an Individual Retirement Account or Individual Retirement Annuity.
   
   
3. The IRA must be invested in a manner that preserves principal and provides a reasonable rate of return, taking into account liquidity and charges that may be assessed. Also, the investment products must generally have a liquidity guarantee, such as being insured by the FDIC, or state guarantee associations. The preamble to the regulations states that the investement products would generally include money market funds, interest-bearing savings accounts, certificates of deposit, and stable-value products.
   
   
4. Fees and expenses of the IRA may not be more than the fees charged by the institution for other rollover IRAs. In addition, with the exception of fees to establish the IRA, the fees may not exceed the income earned by the IRA. While this provision will ensure that the principal remains intact, it is not clear whether this will limit the number of financial institutions that would otherwise be willing to accept these IRAs.
   
   
5. Participants must be provided with a summary plan description (SPD) or summary of material modifications (SMM). The SPD or SMM must provide, among other items, an explanation of the rules, how the IRA and investments are selected, and a contact for further information.
   
   
6. The selection of the IRA and the investment of funds may not result in a prohibited transaction, unless there is an exemption. In that regard, the DOL has also proposed a class exemption that would allow financial institutions that have plans for their employees to establish and invest IRAs within that financial institution (or an affiliate). Without such an exemption, automatic IRA rollovers from the institution's own plan would need to be rolled over and invested in competitor products.

The preamble to the regulations also indicates that there are other issues for which guidance will be issued prior to, or simultaneous with, the issuance of the final DOL regulations. These include items such as conflicts with state laws on signatures and escheat, as well as possible conflicts within the Internal Revenue Code. One potential conflict that appears to have been resolved relates to the USA Patriot Act. Under this Act, the financial institution must identify and verify the IRA holder. Various government agencies have collectively determined that this does not need to be done until the IRA holder first contacts the institution to assert ownership or exercise control of the IRA.

As stated earlier, the automatic IRA rollover rules will not apply until after final regulations are issued. It is not known how long that will take. Comments on these proposed regulations must be received and reviewed by the DOL. In addition, guidance regarding any conflicting laws and regulations must be issued. We will keep you informed as these develop.

The text of the DOL proposed regulation may be found here.

Click here to see the proposed class exemption relating to IRAs established pursuant to automatic rollovers for cash-outs over $1,000.