On September 28, 2004, the U.S. Department of Labor (DOL) issued a final regulation allowing plan fiduciaries to satisfy their fiduciary responsibilities regarding the automatic rollover to individual retirement accounts (IRAs) of certain mandatory distributions. As part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Internal Revenue Code was amended to require that absent an affirmative election by the participant, distributions from qualified plans between $1,000 and $5,000 must be transferred directly to an IRA. The proposed regulation issued in March 2004 indicated this provision would not take effect until a safe harbor regulation regarding plan fiduciaries’ designation of the IRA provider and selection of initial investment elections was issued. Now that the final regulation has been issued, plans with automatic cash-out provisions should be amended. The new regulation applies to the rollover of mandatory distributions made on or after March 28, 2005. However, plan fiduciaries may rely on the regulation prior to the effective date.
Mandatory distributions from all tax-qualified retirement plans covered under Title I of ERISA are subject to the new regulation, including stock bonus, pension and 401(k) plans. Plans that provide for the automatic cash-out of distributions between $1,000 and $5,000 are subject to the new regulation, although the safe harbor may also be extended to amounts less than $1,000. The regulation does not, however, provide a safe harbor for mandatory distributions that are greater than $5,000. Although the effective date of the final regulation is some six months away, plan fiduciaries must take several steps in the coming months to ensure timely compliance. The regulation provides that certain conditions must be satisfied for reliance on the safe harbor, including three key areas relating to agreements with IRA providers, including permissible investment products, and limits on fees and expenses; restrictions on prohibited transactions; and required disclosures to participants.
Agreements with IRA Providers
To comply with the safe harbor regulation, a plan fiduciary must enter into a written agreement with an IRA provider. The agreement must address the investment of the rolled-over funds, as well as applicable fees and expenses related to the IRA. In addition, the participant on whose behalf the IRA is established must be able to enforce the agreement.
The safe harbor also requires that the investment product for the rolled over funds be designed to preserve principal and provide a reasonable rate of return and liquidity with the goal of maintaining the initial investment amount over the term of the investment. Moreover, the product must be offered by a state or federally regulated institution, which includes banks, credit unions, insurance companies and investment companies. The fees and expenses charged for these IRA accounts may not exceed the fees and expense that the IRA provider charges for comparable IRAs established for rollovers that are not mandatory distributions subject to the safe harbor. These fees and expenses include establishment charges, maintenance and investment fees and termination costs. Provided the agreement complies with these requirements, the plan fiduciary’s responsibility ends at the time a participant’s funds are rolled over to the IRA.
Plan fiduciaries may not engage in prohibited transactions in connection with the selection of an IRA or investment product in relying on the safe harbor. Notwithstanding this restriction, the safe harbor references a class exemption from certain prohibited transaction restrictions that was simultaneously published by the DOL, which permits a fiduciary of a plan who is also the employer maintaining the plan to select itself or an affiliate as the IRA provider for automatic rollovers from its plan; to select its own funds or investment products; and to receive fees for these services. Plan fiduciaries relying on the class exemption must still comply with the conditions set forth under the safe harbor. Under the class exemption, however, plan fiduciaries must also limit certain fees and expenses related to the IRA to income earned by the IRA. Although this condition was present in the proposed regulation for the safe harbor, it was removed in the final regulation.
Notice to Participants
Prior to an automatic rollover, plan fiduciaries must provide participants with notice in a Summary Plan Description (SPD) or Summary of Material Modifications (SMM) that describes the plan’s automatic rollover provisions. The notice must also describe the nature of the investment product into which participants’ mandatory distributions will be invested, including an explanation that the product will be designed to preserve principal and provide a reasonable rate of return and liquidity. In addition, the notice must include an explanation of how related fees and expenses will be allocated. The disclosure must also identify the name, address and telephone number of a plan contact from whom participants may obtain further information. Clients may wish to amend their existing rollover notices to reflect all of these changes.
Compliance Efforts Should Begin Now
Plan administrators should begin to take steps now to comply with the new regulation. In particular, administrators should review their plans’ cash-out provisions for required changes, select an IRA provider that will accept the rollovers and update SPDs to include the required participant notices. The IRS is expected to issue guidance prior to the effective date of this safe harbor with regard to any Code requirements that may conflict with the establishment of IRAs for purposes of automatic rollovers of mandatory distributions. However, administrators should not delay their compliance with the DOL’s regulation in anticipation of the IRS guidance.