EGTRRA modified Code §401(a)(31)(B) to provide that mandatory distributions (e.g., involuntary cash-outs) of more than $1,000 and not more $5,000 be automatically rolled over to an IRA if the participant fails to make an affirmative election to receive the distribution or have it rolled-over to another qualifying vehicle. The new rules were not effective until the DOL issued final regulations addressing the fiduciary issues. On September 28, 2004, the DOL issued final regulations that provide a safe harbor for the plan fiduciary in the selection of the IRA and the IRA investment. The new rules apply to distributions occurring on or after March 28, 2005.
In Notice 2005-5, the IRS has provided guidance relating to the application of the new rules as well as guidance relating to plan amendments and employee notices the plan must provide. Unfortunately, there are some issues identified below that are not addressed in the guidance.
Plan Amendments
The guidance provides limited transitional relief with respect to plan amendments. However, the action that an employer or a plan sponsor must take depends on whether (and when) the automatic IRA rules will be implemented for a plan and/or whether a plan's automatic cash-out rules will be modified (e.g., by lowering the involuntary cash-out threshold).
If the new automatic IRA rules will be implemented in 2005
Notice 2005-5 generally provides that employers with plans subject to the automatic IRA rollovers must adopt a "good faith" amendment by the end of the first plan year ending on or after March 28, 2005 (i.e., December 31, 2005 for a calendar year plan or March 31, 2005, for a fiscal plan year ending March 31). The IRS has provided a sample plan amendment that may be used for this purpose. This amendment, or any substantially similar amendment, will be deemed to be a "good-faith" amendment. A prototype plan sponsor can simplify the amendment process by adopting the model amendment on behalf of its employer-clients. The Notice is not clear but we feel the sponsor could adopt a substantially similar amendment on behalf of its clients.
The Notice also provides transitional relief where the rules will be implemented after March 28, 2005 but before December 31, 2005. Normally, a plan can be disqualified for failure to follow the terms of the plan. However, the IRS will not disqualify a plan if the plan does not cash-out a participant who does not elect a rollover or distribution, if the reason for not doing so is because procedures have not been sufficiently established (including establishing IRAs to accept automatic rollovers). This relief only applies if the automatic rollover is made by December 31, 2005.
Example. Plan provides for distributions as soon as reasonably practicable following termination of employment. Bill and Mary terminate employment in April of 2005 with vested account balances of $2,900 and $3,600, respectively. As of the termination dates, the plan has not identified an IRA to which it will make automatic rollovers. Bill makes no election with respect to his distribution after receiving the plan's distribution notices (e.g., the 402(f) notice and distribution election form), and therefore the plan delays, pursuant to the transitional rule, providing the distribution until November 1, 2005 when it has selected an IRA for the automatic rollovers. The plan presumably will need to provide Bill with new distribution notices. The notices provide that in the absence of an election by December 15, 2005 to receive the distribution or roll it over the plan will automatically roll over the account to the First National Bank IRA. Bill does not respond and the plan automatically rolls over his account to the IRA on December 29, 2005. Mary, on the other hand, elects to receive a distribution. Since Mary has made an affirmative election, the plan makes her distribution.
- If the new automatic IRA rules will NOT be implemented in 2005
Unfortunately, Notice 2005-5 provides no relief from plan amendments where the automatic IRA rollovers will not be implemented in 2005. Without any transitional relief, a plan can be disqualified if it is not operated in accordance with the terms of the written plan. The two situations where this will be problematic are: (1) where the automatic IRA rollover rules will be implemented but the plan administrator will not be able to establish the procedures by the end of 2005; or (2) where the plan's automatic cash-out rules will be modified to eliminate the need to comply with the automatic rollover rules (e.g., lowering the involuntary cash-out threshold to $1,000).
The Notice clarifies that a plan's automatic cash-out provisions can be amended without violating the anti-cutback rules of Code §411(d)(6). However, the Notice does not provide any transitional relief for employers eliminating or suspending cash-outs. In fact, the Notice appears to require the plan to be amended to modify the cash-out rules prior to operationally implementing the new provisions. This means that if a plan's automatic cash-out rules are going to be suspended beyond 2005 or modified in any other way, then a plan amendment may be needed no later than March 28, 2005.
Although Notice 2005-5 does not provide any transitional relief, Notice 2001-42 (guidance relating to good-faith EGTRRA amendments) may provide relief. We are contacting the IRS to determine the timing for adopting an amendment to eliminate or suspend involuntary cash-out distributions.
The IRS has not provided a sample amendment that eliminates cash-outs or lowers the cash-out threshold to $1,000. We intend to create such an amendment. We will send another technical update once we have posted this amendment to our Web site. However, prior to posting the amendment, we will need to contact the IRS to determine whether the adoption of such an amendment will endanger reliance for a prototype or volume submitter plan sponsor. We also will request clarification as to whether such an amendment will be able to be adopted at the sponsor level.
Participant Notification
Code §401(a)(31)(B)(i) requires the plan administrator to notify a participant receiving a mandatory distribution that, absent a participant’s affirmative election to receive the distribution or roll it over, the plan will automatically roll over the distribution to an IRA. The notice must identify the IRA to which the automatic rollover will be made. The employer may satisfy this notice requirement by modifying the 402(f) notice or providing another notice. The IRS does not intend to modify its model 402(f) notice. Therefore, we will make appropriate modifications to our distribution election form rather than to the 402(f) notice. Practitioners should note that the IRS notice requirement is over and above the DOL requirement that an employer modify its SPD or provide a summary of material modification explaining the automatic rollover rules to qualify for the fiduciary safe harbor.
The Notice does resolve an issue relating to a potentially missing participant. The guidance provides that a plan will not fail to satisfy the notice requirement because the U.S. Postal Service returns the notice as undeliverable, so long as the plan sent the notice to the last known mailing address.
Application to Certain Plans
Notice 2005-5 also provides guidance regarding the application of the new automatic IRA rollover rules to certain plans. In general, the new rules apply to governmental plans (Code §414(d)), governmental eligible deferred compensation plans (Code §457(b)), church plans (Code §414(e)) and 403(b) plans (Code §§403(b)(1), (b)(7) and (b)(9)).
Governmental plans may be eligible for additional time in which to adopt the automatic rollover amendment.
Establishment of IRA
The Notice indicates that the plan administrator (generally, the employer) may execute the IRA documents to establish the automatic rollover IRA. The Notice also indicates that the IRA provider may use the last known mailing address of the plan participant for purposes of complying with the IRA disclosure requirements. A plan also may use a deemed IRA existing within in the plan as the IRA to which it makes the automatic rollover.
Amounts subject to automatic rollover rules
The automatic rollover rules generally apply to mandatory distribution amounts in excess of $1,000 but not in excess of $5,000. However, if the plan has elected to disregard rollover amounts in determining whether the cash-out distribution amount exceeds $5,000, the automatic rollover rules also will apply to the rollover amount, even if it exceeds $5,000. Another area of confusion that we hope will be resolved is whether the fiduciary safe-harbor rules would apply if the total amount that is automatically rolled into an IRA exceeds $5,000.
Stay tuned for amendments and further updates
We will post materials to our Web site to address these new rules. These materials will include plan amendments, SMMs and participant notices. As indicated earlier, some of these may depend on further IRS guidance. We will keep you up-to-date with another technical update as we know more.
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