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Automatic IRA Rollovers of Cash Outs
By: George M. Morrison

             ERISA and the Code permit a plan to provide a mandatory distribution of terminated participant balances which do not exceed $5,000.  Participants who terminate with less than $5,000 are eligible to rollover such amount to another plan or IRA.  However, if they fail to do so, a taxable lump-sum distribution is made.

            Most 401(k) plans impose mandatory cashouts, usually in an effort to limit the number of small accounts under the plan.  Not providing a mandatory distribution not only leads to a larger number of participant accounts which must be maintained, but often leads to difficulty finding such participants in the future. 

            When EGTRRA was enacted in 2001, it included a provision which required mandatory cashouts of between $1,000 and $5,000 be rolled-over to an IRA, unless the participant affirmatively elects a distribution.  Thus, under EGTRRA, if a participant terminates with a balance between $1,000 and $5,000 and fails to elect a cash distribution or rollover to another plan or IRA, his or her account must be rolled-over to IRA and not distributed to the participant.  This provision of EGTRRA, however, was not to be effective unless and until the DOL issued regulations which provided plan fiduciaries some protection regarding the automatic IRA rollover. 

            In September 2004, the DOL issued regulations which establish a fiduciary safe harbor for automatic IRA rollovers.  These regulations are effective March 28, 2005, but can be relied-upon in good faith until then. 

            The DOL’s regulations provide fiduciaries safe harbor relief for the selection of an IRA provider and the selection of the initial investments for such IRA.  Qualifying for the fiduciary safe harbor is contingent upon the satisfaction of the following requirements. 

• The cashout distribution is rolled over to any individual retirement plan or IRA.  The regulations impose no special requirements related to the IRA provider’s financial stability.
• Plan fiduciaries must have a written agreement with the IRA provider that specifically addresses the investment of rolled over amounts and the related fees and expenses.  The DOL anticipates that this information will be addressed in documents currently utilized by the IRA providers in their normal course of business.
• Investments selected must be products designed to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed, consistent with liquidity.  The DOL provided the following examples of products that meet that requirement: money market funds, interest-bearing savings accounts, and CDs, as well as “stable value” products that offer a liquidity guarantee.
• The IRA custodian may charge fees and expenses against the IRA as long as the fees and expenses would not exceed what would ordinarily be charged for a comparable IRA established in other non-automatic rollover situations.
• Participants must receive an SPD or SMM that explains the plan’s procedure for automatic rollovers, including a description of the investment product and method used to allocate fees.  In addition, the SPD or SMM must include a plan contact person from whom the participant can obtain more information about the IRA provider and associated fees.

In advance of the March 28, 2005 effective date of these regulations, all plan sponsors should receive information from the investment institute handling their plan regarding automatic rollovers.  In addition, SPDs and SMMs must also be updated.