Many governmental retirement plans have missing and non-responsive participants, whose accounts remain in the retirement plan, increasing plan sponsor liability and plan administration costs each year. To help reduce these expenses, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended the Internal Revenue Code (Code) to allow plans to establish IRAs for former employees with plan balances less than or equal to $5,000. Automatic rollover provisions apply to government plans, since these plans are §414(d) plans that are required to comply with Code §401(a)(31). Governmental plans can include pension plans, individual account plans including grandfathered Code §401(k) plans, Code §403(b) plans and Code §457(b) plans. Automatic rollovers are a valuable tool for plan sponsors and other plan fiduciaries of governmental plans. Automatic rollovers allow plan sponsors of governmental retirement plans to effectively outsource participant accounts to a qualified IRA provider, thereby saving money, time and valuable personnel resources, and at the same time, preserving tax deferred retirement savings for their former employees.
ROLLOVER SAFE HARBOR
On September 28, 2004, the Department of Labor (DOL) published final regulations providing plan sponsors a safe harbor for rolling over distributions to IRAs. Governmental plans are generally not subject to the rules under the Employee Retirement Income Security Act (ERISA), though certain plan sponsors may elect to treat Code §403(b) plans as ERISA-covered plans. However, any retirement plan that is subject to the automatic rollover requirements under Code §401(a)(31) may, upon advice of legal counsel, be administered in accordance with the DOL safe harbor rules.
If done in accordance with these rules, the plan sponsor will be deemed to satisfy its fiduciary duties. The safe harbor requirements are:
- The present value of the participant’s vested account balance may not be more than $5,000, or, if the plan so provides, $5,000 plus amounts (and earnings) rolled over from other plans.
- The plan fiduciary must enter into a written Automatic Rollover agreement with an IRA provider addressing the initial investment, services and related fees and expenses.
- The initial investment product must be offered by a state or federally regulated financial institution, such as a bank, trust company, credit union, insurance company, or ’40 Act investment company.
- The initial investment product must be designed to minimize risk, preserve principal, provide a reasonable rate of return and maintain liquidity. Examples provided include money market funds, interest-bearing savings accounts, certificates of deposit and stable value products.
- The fees and expenses cannot exceed those charged by the selected IRA provider for its other comparable IRAs.
- The plan sponsor must provide information about the automatic rollover process and the investment products offered to all participants in either a Summary Plan Description (SPD) or Summary of Material Modifications (SMM).
Plan fiduciaries are not required to monitor the IRA or the former employee after the funds are rolled over. The terms of the IRA agreement are enforceable by the participant on whose behalf the rollover was made.
Since the plan terms are no longer applicable, any specified beneficiary designation and investment election made under the retirement plan ends when the rollover is made. The IRA terms will prospectively govern the individual’s beneficiary designation and investment of assets.
The IRS issued model plan amendment language that can be used by governmental plans to adopt the automatic rollover rules into their tax qualified plan; the plan fiduciary cannot implement automatic rollovers unless the plan has the appropriate language.
Additionally, this model plan language can be altered to include automatic rollovers for participants with balances of $1,000 or less since the IRS clarified that the automatic rollover also applies to these small distributions. This can significantly reduce administrative expenses for missing participants of which distribution checks have been returned as lost addresses.
- Enter into a written Automatic Rollover agreement with a qualified IRA provider.
- Amend the plan document to provide for automatic rollovers.
- Make appropriate disclosures to plan participants about the selected IRA provider and investments via an updated SPD or SMM before automatic rollovers begin.
- Be prepared to modify the “special tax notice” required under Code §402(f) for all eligible rollover distributions to explain the automatic rollover rules.