The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended the Tax Code, adding a requirement that mandatory distributions in excess of $1,000, but less than or equal to $5,000, must be paid directly to an Individual Retirement Account (IRA) unless the participant makes an affirmative election to have the amount distributed to him or her or rolled over to an eligible retirement plan. This new requirement applies to plans qualified under Sections 401(a) and 401(k) of the Code, as well as to 403(b) plans, governmental plans, church plans and 457 plans.
A mandatory distribution is one that is made without the participant's consent and prior to the participant turning 62 or attaining normal retirement age, whichever occurs later. A distribution to someone other than the participant is not considered a mandatory distribution for the purposes of the automatic rollover rules. Further, EGTRRA added a notice provision requiring plan administrators to notify the participant in writing that the distribution would be paid in a direct rollover to an IRA. This notice must be provided before the mandatory distribution is made, and, in order for the employer to qualify for the protection of the fiduciary safe harbor (discussed below), must be accompanied by a special tax notice, describing the tax consequences of rollovers, and an updated Summary of Material Modifications or Summary Plan Description, describing the plan's automatic rollover procedures.
PLAN SPONSOR OBLIGATIONS
Before March 28, 2005, Plan Sponsors need to address automatic cash outs and operationally implement these new procedures. However, like all plan amendments, employers must notify all participants of the change in the plan. This may be done by providing a Summary of Material Modifications or restating the Summary Plan Description. Notice to participants should be prepared and distributed prior to March 28, 2005, and must be distributed prior to the first mandatory distribution under the plan. Failure to satisfy these requirements will prevent the employer from qualifying for the relief afforded under the fiduciary safe harbor (discussed below).
Materials should contain contact information so employees can obtain more information about the changes and how they are affected. The IRS recently issued guidance confirming that plan amendments reflecting the automatic rollover requirements need to be adopted by the end of the first plan year ending on or after March 28, 2005. However, as a practical matter, most employers will want to amend their plans by March 28, 2005 -- to make sure that the "summaries" accurately reflect the terms of the amendment. Also, the plan's special tax notice describing certain tax considerations implicated by the automatic rollover rules must be updated to include the new provisions.
FIDUCIARY SAFE HARBOR
The Department of Labor (DOL) has issued final safe harbor regulations addressing two aspects of the automatic rollover process: a) the fiduciary decision to select an institution to provide the IRA; and b) the selection of investments. Plans that qualify for the safe harbor are not required to investigate the financial stability of the IRA provider or to monitor the IRA's investments. Once the initial investment choice is made, the funds are rolled over to the IRA, and the Plan Sponsor's fiduciary obligation with respect to the investment of these funds will cease.
Pursuant to the final DOL regulation, a Plan Fiduciary must satisfy six requirements to receive the protection offered by the safe harbor:
1. The benefit subject to the automatic rollover requirement may not exceed $5,000. In addition, the Plan may disregard amounts rolled over from other plans in determining whether the benefit exceeds the $5,000 threshold. However, these rolled over amounts may be included in the mandatory distribution and automatic rollover and are eligible for the safe harbor protection.
2. The Plan Sponsor must open a qualified IRA in the participant's name. The IRA provider must be a state or federally regulated financial institution. Examples include FDIC insured banks, insurance companies, FCUA insured credit unions and mutual fund companies registered under the Investment Company Act of 1940.
3. The Plan Sponsor and the IRA provider must agree in writing that assets in the IRA will be invested in products that seek to preserve principal and provide a reasonable rate of return, whether or not such return is guaranteed and consistent with liquidity. Such products would generally include money market mutual funds, interest-bearing savings accounts, certificates of deposit and stable-value funds, etc.
4. The fees and expenses charged for establishing and maintaining the IRA may not exceed the expenses charged by the IRA provider for comparable IRAs for rollovers established for other reasons.
5. The Plan Sponsor must provide participants and beneficiaries with notice about the automatic rollover procedure. This information must describe the investment product and the allocation of any fees and expenses among the IRA, the distributing Plan and the Plan Sponsor. Furthermore, the disclosure must identify the Plan contact and must be provided in advance of the automatic rollover.
6. The Plan Fiduciary may not engage in any prohibited transaction in connection with selecting the IRA provider of the investments. For example, the Plan Fiduciary may not designate itself as the IRA custodian or investment manager, unless the conditions of a prohibited transaction class exemption previously released by the DOL are satisfied.
BROWN RUDNICK'S EMPLOYEE BENEFITS & EXECUTIVE COMPENSATION PRACTICE GROUP represents businesses at all stages of development, including emerging growth companies, public companies and large private institutional businesses. We provide a wide range of legal and consulting services to cover the many aspects of employee benefits law, including design, implementation and administration of benefit plans and programs. In this complex area, we provide an aggressive, results-oriented approach to meet the specific business goals of our clients.
Harvey M. Katz
212.209.4860
hkatz[at]brownrudnick.com
James L. Hauser
617.856.8130
jhauser[at]brownrudnick.com
Adam B. Cantor
212.209.4896