The Department of Labor (the “DOL”) issued a final regulation on September 28, 2004 that establishes a safe harbor pursuant to which a fiduciary of a retirement plan subject to Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”) may meet its fiduciary responsibilities with respect to the automatic rollover of mandatory cash-outs to individual retirement plans. Plan sponsors are required to provide for the automatic rollover of certain mandatory cash-outs by the effective date of this safe harbor final regulation. As discussed in more detail below, the safe harbor criteria of the final regulation include some important differences from the proposed regulation.
The Economic Growth and Tax Reconciliation Relief Act (“EGTRRA”) amended Internal Revenue Code (“Code”) section 401(a)(31), the section which deals with direct transfers of rollover distributions, to include a requirement for an automatic rollover to an individual retirement plan where an amount in excess of $1,000 but no more than $5,000 is to be distributed without the participant’s consent. In such a case, unless the participant makes an affirmative election for a rollover to his or her own IRA or another qualified plan, or elects to take the distribution directly, the plan must make the distribution in the form of a rollover distribution to an individual retirement plan. The individual retirement plan can be either an individual retirement account or an individual retirement annuity (both referred to in this article as “IRAs”).
EGTRRA stipulated that the automatic rollover requirement is to be effective six months after the DOL publishes a final regulation providing plan fiduciaries with safe harbor criteria for selecting an IRA and the investment options. The DOL issued a proposed regulation, sought comments from the industry, and restructured the final regulation accordingly. The DOL issued its final regulation on September 28, 2004 and, as a result, plan sponsors should be prepared to implement the automatic rollover rules for mandatory cash-outs made after March 28, 2005.
Safe Harbor for Automatic Rollovers
The final regulation provides for a safe harbor that, if satisfied, will protect plan fiduciaries from claims of breach of fiduciary duties in complying with the automatic rollover rules. The DOL indicates that the safe harbor is not the exclusive means of satisfying both fiduciary duties and the rollover rules. However, absent other guidance, the safe harbor is the most feasible way to ensure that plan fiduciaries meet their fiduciary responsibilities.
The final regulation provides that safe harbor relief is dependent on a fiduciary satisfying the following conditions:
- Amount of the Mandatory Distribution
The amount to be rolled over to the IRA under the automatic rollover rules may not exceed $5,000, excluding amounts attributable to prior rollovers. If a distribution of more than $5,000 is inadvertently rolled over to an IRA without the participant’s consent, the safe harbor will not apply. Importantly, the final regulation differs from the proposed regulation by providing that a distribution of less than $1,000 that is automatically rolled over to an IRA (even though not required by the Code) will be covered by the safe harbor. However, it is unclear at this time whether IRA providers will accept amounts less than $1,000, as such amounts may not exceed minimum account balance requirements of the IRA or be otherwise viewed as not economically feasible by the IRA provider. The DOL declined to extend the safe harbor to distributions in excess of $5,000, presumably because amounts over $5,000 may be rolled over to an IRA only at the direction of the participant and, therefore, the fiduciary should not be at risk for breach of fiduciary duty.
- Qualification of IRA Providers
The rollover vehicle must be an IRA meeting the requirements of either Code section 408(a) or 408(b). The DOL states in the preamble that multiple IRA providers may be offered under a plan.
- Agreements with Individual Retirement Plan Providers
The final regulation differs from the proposed regulation by providing that in order to evidence compliance with the safe harbor, a fiduciary must enter into a written agreement with an IRA provider that specifically addresses such issues as the investment of the funds and the IRA fees and expenses. Importantly, the DOL states in the preamble that the fiduciary must only confirm that the written agreement contains the requisite provisions of the safe harbor and that the fiduciary will not have a duty to investigate or monitor the actual investments of the IRA or its fees and expenses. The final regulation also provides that the terms of the written agreement are enforceable by the participant for whom the automatic rollover was made to the IRA. Providing this relief to a fiduciary was crucial in balancing the intent to preserve retirement assets with the administrative benefits derived from the plan’s ability to cash-out small amounts without participant consent. Key provisions required to be in the provider agreements are as follows:
- Permissible Investments
The written agreement must provide that the IRA is to invest the rolled over amounts in investments designed to preserve principal while providing for a “reasonable” rate of return, whether or not the return is guaranteed. Thus, the investment product must be one that minimizes risk and seeks to maintain a stable dollar value (examples given include money market funds, savings accounts and certificates of deposit). While any entity allowed under the IRA rules to hold IRA assets may receive a rollover under the safe harbor, the final regulation provides that only products offered by a State or federally regulated financial institution (e.g., banks, credit unions, licensed insurance companies and registered mutual funds) may be used for the IRA investments. As mentioned above, as long as the written agreement provides for only these permissible investment vehicles, the plan fiduciary is not required to investigate or monitor the actual investments of the IRA. In keeping with its intent to preserve retirement assets, the DOL declined to expand the permissible investments to include investment products identical to or similar to those under the qualified plan or to other balanced or diversified funds.
- Fees and Expenses
The written agreement must also provide that the IRA fees will not exceed the fees charged by the institution for comparable IRAs established for rollover distributions. As with permissible investments, the safe harbor only requires that the written agreement set forth the rule regarding permissible fees and expenses; the fiduciary is not required to investigate or monitor the actual fees and expenses charged by the IRA. Importantly, due to concerns of IRA providers, the final regulation differs from the proposed regulation by deleting the requirement that the fees and expenses, other than those attributable to establishment of the IRA, could be charged only against the income earned by the IRA. The IRA providers were concerned that this limitation would make automatic rollover IRAs financially impractical because the costs associated with the IRAs may exceed the expenses that could be charged. The DOL recognized their concern and modified the final regulation to eliminate this disincentive for IRA providers.
- Permissible Investments
- Notice Requirements
Participants must be given information prior to the automatic rollover, in either a summary plan description or a summary of material modifications, describing the types of investments that will compose the IRA and how fees will be charged and allocated under the IRA. The final regulation does not require the amount or rate of the fees to be disclosed in these documents, presumably because the fees will change from time to time and from institution to institution. The participants also must be informed of the person to contact to obtain more information about the investment of the mandatory rollover, including specific provider information. The DOL declined to broaden the disclosure requirements to provide an additional disclosure to separating participants at the time a distribution is made from the plan.
- Prohibited Transactions
Safe harbor relief is also conditioned upon the fiduciary not engaging in a prohibited transaction in connection with the selection of the IRA provider or investment products unless covered by a statutory or administrative exemption. Simultaneously with the publication of the final regulation, the DOL issued a final class exemption (PTE 2004–16, 69 FR 58018) which would allow plan sponsors to use their own IRA custodial services and products for mandatory rollovers from their plans and receive fees for such services. However, the exemption provides that expenses associated with maintaining IRAs for their employees must be limited to investment earnings and that no sales commissions may be charged to these accounts.
Issues beyond the Scope of the Final Regulation
The DOL did not address what plan sponsors should do if a participant cannot be located at the time of the mandatory cash-out.¹ The DOL also did not address whether outstanding participant loans would constitute a portion of the accrued benefit for purposes of determining if the amount of the mandatory cash-out satisfies the safe harbor. Finally, the DOL did not address any Code requirements that may conflict with the automatic rollover rules, but stated in the preamble that the Department of Treasury and the IRS are reviewing the current rules, and guidance addressing any possible conflicts is anticipated before the effective date of the final regulation.
Next Steps for Plan Sponsors
Plan sponsors should take certain steps to ensure compliance with the automatic rollover rules and the safe harbor by the effective date of the final regulation.
- Determine Whether to Retain Mandatory Cash-Outs
Plan sponsors first will need to determine whether to retain the mandatory cash-out provision in their plans. While we believe the ability to force a distribution of small amounts may be administratively desirable, some plan sponsors may feel the effort required to satisfy the safe harbor is not worth retaining the mandatory cash-out. Plan sponsors should weigh these competing factors when making this determination.
- Identify and Enter into Agreement with IRA Provider
Plan sponsors will need to identify IRA providers that will accept automatic rollovers and enter into written agreements with them that meet the safe harbor criteria. Since plan vendors have just learned what services may be provided with respect to automatic rollovers, identifying IRA providers may take some time. However, two of the largest plan vendors have indicated to us that they are planning to develop a safe harbor IRA product for their customers. To assure adherence to fiduciary requirements, plan fiduciaries also need to exercise care and prudence in selecting an IRA provider.
- Amend Plan Documents
Plan sponsors will need to amend their plans to reflect the automatic rollover rules if the plan is to provide for the mandatory cash-out of small amounts. Some plans may already have been amended under EGTRRA in anticipation of the adoption of the final regulation.
- Amend Summary Plan Description and 402(f) Notice
Plan sponsors also will need to prepare new summary plan descriptions or summaries of material modifications, describing the automatic rollover provisions and conforming to the safe harbor. Since EGTRRA amended Code section 402(f) to require that the 402(f) tax notices contain a description of the automatic rollover procedures, these notices will need to be revised as well.
Plan sponsors should complete the steps we have outlined prior to March 28, 2005. If plan sponsors want to implement automatic rollovers before March 28, 2005, they may rely in good faith on the final regulation effective immediately.
¹ However, in Field Assistance Bulletin 2004–2 (September 30, 2004), the DOL has stated that the safe harbor will also protect the fiduciaries of a terminated defined contribution plan where the accounts of missing participants (including accounts in excess of $5,000) are rolled over into IRAs that conform to the final regulation.