IRS ISSUES AUTOMATIC ROLLOVER RULES

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1 JANUARY 14, 2005 IRS ISSUES AUTOMATIC ROLLOVER RULES By Laura D. Sanborn, Esq. In Notice issued on December 28, 2004, the Internal Revenue Service ( IRS ) has provided time-critical guidance on automatic rollover provisions under the Internal Revenue Code ( Code ). Companies with retirement plans that provide for mandatory cash-outs of small accrued benefits need to consider taking action by March 28, Background Under Code Section 401(a)(31) of the Code, a recipient of any eligible rollover distribution may elect to have the distribution paid directly to an eligible retirement plan in the form of a direct rollover. The plan administrator must provide a written explanation to the recipient of the tax and distribution issues relevant to the recipient (known as a 402(f) notice). In order to enable plans to deal with small account balances (where the participant would be unlikely to direct the plan administrator as to how benefits should be paid), qualified plans are permitted to include provisions whereby distributions may be made to participants who separate from employment and have less than $5,000 in their account balances. Forced cash-outs like these are known as mandatory distributions. The Economic Growth and Tax Relief Reconciliation Act of 2001 ( EGTRRA ) amended the Code by adding a requirement that mandatory distributions in excess of $1,000 must be paid in a direct rollover to an individual retirement account ( IRA ) if the participant does not make an affirmative election otherwise. Along with this requirement, EGTRRA added a notice provision to Code Section 401(a)(31)(B). Plan administrators must notify the participant in writing that the distribution will be paid in a direct rollover to an IRA. Pursuant to EGTRRA, the automatic rollovers of mandatory distributions did not become effective until the Department of Labor issued safe harbor regulations (which it did on September 28, 2004 to be effective March 28, 2005). These regulations provided plan administrators with guidance and safe harbors that would enable them to avoid violations of their fiduciary obligations during the rollovers to IRAs.

2 The December 2004 issue of NP Benefits Briefs, vol 17, no. 5 discusses recent Department of Labor regulations. Go to to view the Benefits Briefs and read more about the regulations. Automatic Rollover Provisions A qualified plan must satisfy the automatic rollover provisions of Code Section 401(a)(31)(B) in order to continue to remain qualified. These automatic rollover provisions apply to any mandatory distribution that is more than $1,000 and is an eligible rollover distribution that is subject to the direct rollover requirements of Code Section 401(a)(31). The notice defines a mandatory distribution as one that is made without the participant s consent and prior to the later of the participant s attainment of age 62 or normal retirement age. A distribution to a surviving spouse or an alternate payee is not a mandatory distribution for purposes of the automatic rollover rules. In addition, a plan loan offset is not subject to the automatic rollover provisions. In order to satisfy the automatic rollover provisions, if the plan provides for mandatory distributions, a plan must provide that if a participant fails to affirmatively elect to receive a distribution directly or roll that amount over to an eligible retirement plan after receiving the required notice, a mandatory distribution that exceeds $1,000 and that is an eligible rollover distribution will be rolled over to an IRA. According to the Notice, a plan subject to the joint and survivor annuity rules will not be in violation of that plan s spousal consent requirements due to the automatic rollover provisions so long as no amount greater than $5,000 will be distributed without the consent of the spouse. With respect to the total amount subject to the automatic rollover provisions, these provisions apply to the entire amount of a mandatory distribution. This means that the amount of a distribution attributable to rollover contributions (which may be excluded from the determination of whether a participant s account balance is under $5,000) must be directly rolled over to an IRA, if there is no election otherwise. The IRA Although the specifics relating to the terms of the IRA are not set out in the Notice (these are outlined in the Department of Labor regulations published in September), the Notice does provide some information on the roles of the plan administrator and the IRA trustee in this process. If a participant fails to make an election to have the mandatory distribution paid to him directly or rolled over to an eligible retirement plan, the plan administrator may establish an IRA on the participant s behalf with a financial institution selected by the plan administrator. The participant s last known mailing address may be used for purposes of establishing the IRA. Pursuant to regulations issued under Code Section 408, the IRA s trustee must provide a disclosure statement to the participant and provide a revocation period. The return of this disclosure statement by the US Postal Service as undeliverable will not cause the IRA trustee to fail to satisfy the disclosure requirement so long as the participant s last known address on file with the plan administrator is used. 2 of 5

3 If the plan includes deemed IRAs, instead of rolling over the mandatory distribution to a separate IRA maintained by a financial institution, mandatory distributions may be paid to a deemed IRA within the plan. The Notice The notice describing the automatic rollover provisions may be incorporated in the 402(f) notice or it may be provided in a separate document. The notice must identify the IRA s trustee and it may be sent electronically in accordance with the regulations under Code Section 402(f). As with the IRA disclosure document, the return of this notice by the US Postal Service as undeliverable will not cause the plan to fail to satisfy the notice requirement so long as the participant s last known address on file with the plan administrator is used. The Effective Date The automatic rollover provisions apply as of March 28, However, if a plan provides for mandatory distributions and the plan administrator has not sufficiently established administrative procedures to permit accomplishment of the automatic rollover on or after March 28, 2005, the plan will not be treated as failing to operate in accordance with its terms. Such procedures must be in place, however, by December 31, 2005, as the IRS lenience will not extend to distributions after December 31, (Note that a later compliance date may apply for certain plans see below). Application of the Automatic Rollover Provisions to Certain Plans Governmental Plans The automatic rollover provisions apply to government plans (described in Code Section 414(d)) that are required to comply with Code Section 401(a)(31). However, governmental plans have a longer time to comply as the automatic rollover provisions will not apply to mandatory distributions from such plans made prior to the close of the first regular legislative session of the legislative body with the power to amend the plan that begins on or after January 1, In addition, the automatic rollover provisions (with the delayed compliance date) apply to governmental eligible deferred compensation plans. Code Section 403(b) Plans The automatic rollover provisions apply to annuity contracts (described in Code Section 403(b)(1)), custodial accounts (described in Code Section 403(b)(7)), and retirement income accounts (described in Code Section 403(b)(9)). If a 403(b) plan is a governmental plan (within the meaning of Code Section 414(d)), then the delayed compliance date for governmental plans applies. Church Plans Church plans (within the meaning of Code Section 414(e)) that elect to be subject to the qualification requirements of Code Section 401(a) will be subject to the automatic rollover provisions (with no delayed compliance date). In addition, the automatic rollover provisions apply to those church plans that have not elected to be subject to the qualification requirements (i.e., non-electing church plans). However, a delayed compliance date applies to certain non-electing church plans a non-electing church plan for which the power to amend is held by a church convention (within the meaning of Code Section 414(e)(3)) has 3 of 5

4 until 60 days after the close of the earliest church convention that occurs on or after January 1, 2006, to comply. Action Items Amend the Plan If a plan provides for mandatory distributions and it does not already include the automatic rollover provisions, the plan must adopt a good faith amendment by the end of the plan year ending on or after March 28, 2005 (or, if applicable, the delayed compliance date). The Notice includes the following language that individual plan sponsors and sponsors of preapproved plans can use or adopt in drafting plan amendments: In the event of a mandatory distribution greater than $1,000 in accordance with the provisions of section, if the participant does not elect to have such distribution paid directly to an eligible retirement plan specified by the participant in a direct rollover or to receive the distribution directly in accordance with sections(s), then the plan administrator will pay the distribution in a direct rollover to an individual retirement plan designated by the plan administrator. Notify Participants As with any plan amendment, notice must be given to participants of the change in the plan. Revised summary plan descriptions or summaries of material modifications must be provided to participants describing the automatic rollover provisions. These materials should be prepared and distributed prior to March 28, 2005 (or at a minimum, prior to the first mandatory distribution after March 28). Become operationally compliant It is not sufficient to simply amend the plan to include the automatic rollover provisions. Prior to March 28, 2005, plan administrators and fiduciaries need to identify IRA providers who will accept the automatic rollovers. Again, the Department of Labor regulations issued in September should be consulted during this process to ensure that the safe harbor provisions are followed. Prepare New Notices/Update 402(f) Notices Because a notice must be provided to distributees prior to the automatic rollover of a mandatory distribution, either a new notice must be prepared describing the provisions or the plan s 402(f) notice must be updated to include the new provisions. It is expected that the IRS will issue a new model 402(f) notice soon. Consider an Alternative Instead of amending plans to comply with the automatic IRA rollover provisions, plan sponsors may choose instead to eliminate the mandatory distribution features of their plans. The Notice states that such a change will not violate the anti-cutback provisions of Code Section 411(d)(6). In particular, plan sponsors may amend their plans either (i) to eliminate altogether the automatic distribution of small account balances from their plans or (ii) reduce the maximum automatic cashout to accounts of $1,000 or less. The latter approach would allow plans to rid themselves of very small accounts without having to deal with any administrative complexity of complying with the automatic IRA rollover rules. 4 of 5

5 Employee Benefits Team Please feel free to call or your usual contact or any of the attorneys on our Employee Benefits Team listed below. ATTORNEY NAME PHONE BOSTON Thomas McCord tmccord (617) Laura Sanborn lsanborn (617) ROCHESTER Christian Hancey chancey (585) Brian Kopp bkopp (585) Bob Wild rwild (585) Albany, NY Omni Plaza 30 South Pearl Street Albany, NY Boston, MA 100 Summer Street Boston, MA Buffalo, NY 1600 Main Place Tower Buffalo, NY Garden City, NY 990 Stewart Avenue Garden City, NY Hartford, CT CityPlace 185 Asylum Street Hartford, CT Manchester, NH 889 Elm Street Manchester, NH McLean, VA 2010 Corporate Ridge, Suite 700 McLean, VA New York, NY 437 Madison Avenue New York, NY Orange County, CA 2040 Main Street, Suite 850 Irvine, CA Philadelphia, PA 1818 Market Street Philadelphia, PA Providence, RI One Citizens Plaza Providence, RI Rochester, NY Clinton Square Post Office Box Rochester, NY San Francisco, CA Two Embarcadero Center San Francisco, CA Washington, DC 401 9th Street, N.W., Suite 900 Washington, DC