Automatic Rollover Safe Harbor Guidance:
DOL Rolls Out New Proposed Regulation

By Jason T. Froggatt
[March 2004]

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) required qualified plans to transfer certain mandatory distributions directly to an individual retirement plan absent an alternative affirmative election by the participant. In particular, the new provisions of Code section 401(a)(31) require that mandatory distributions (cashouts of vested benefits that do not exceed $5,000) in excess of $1,000 be transferred to an individual retirement plan in the name of the participant unless the participant affirmatively elects to receive the distribution directly or to have the distribution paid directly to an eligible retirement plan. The effective date of this requirement was delayed until the Department of Labor (DOL) issued regulations creating a fiduciary safe harbor for automatic rollovers. On March 2, 2004, the DOL issued a proposed regulation creating such a safe harbor. This means that qualified plans must prepare to implement automatic rollovers to individual retirement plans.

Who Must Comply?

The automatic rollover provisions apply to all retirement plans that are tax-qualified under Code section 401(a), including defined contribution plans such as profit-sharing plans and 401(k) plans, and defined benefit plans including cash balance plans or money purchase plans. The provisions also apply to 403(b) plans and 457 plans that are sponsored by state or local government agencies. The safe harbor, however, only applies to plans that are subject to the Employee Retirement Income Security Act (ERISA). Plans that are subject to the automatic rollover provisions, but are not subject to ERISA, such as governmental 457 plans, are not covered by the safe harbor. Nevertheless, such plans might want to consider following the safe harbor guidance in the administration of the automatic rollover provisions of their plans.

When Is Compliance Required?

Compliance with the automatic rollover requirements will be required six months after the final safe harbor regulation is published. The final regulation may be published as soon as June 2004, with an expected compliance date of January 2005.

What are the Conditions for the Safe Harbor?

The proposed safe harbor is for plan fiduciaries that want certainty about the potential liability for selecting an individual retirement plan provider to which automatic rollovers are made. Under the proposed regulation, the safe harbor has six conditions. Three of the conditions are straightforward: (1) the present value of the vested accrued benefit must not exceed the maximum amount permitted under 401(a)(31)(B) (currently $5,000, not including rollover contributions); (2) the automatic rollover must be made to an individual retirement account or individual retirement annuity; and, (3) the plan fiduciary must not engage in prohibited transactions in connection with the selection of an individual retirement plan provider or investment product, unless such actions are covered by a statutory or administrative exemption. In conjunction with the issuance of the proposed regulation, the DOL has also issued a proposed prohibited transaction exemption intended to permit a bank or other financial institution to select itself or an affiliate as the individual retirement plan trustee or custodian to receive rollovers from its own plan and select its own funds or investment products for automatic rollovers from its own plan.

At the heart of the safe harbor are three other conditions:

Investment Products. The safe harbor provides for the investment of a mandatory distribution in investment products designed to preserve principal and provide a reasonable rate of return. The rate of return does not have to be guaranteed. The investment product must be reasonably liquid, taking into account the extent to which charges can be assessed against the individual retirement plan. The product must be offered by a state or federally regulated financial institution and must attempt to maintain a stable dollar value equal to the amount invested in the product by the individual retirement plan.

Investments under the safe harbor should be designed to minimize risk, preserve assets for retirement and maintain liquidity. Exemplary safe harbor investment products include money market funds, interest-bearing savings accounts and certificates of deposit. Additionally, “stable value products” issued by a regulated financial institution can be safe harbor investment products if they do not impose restrictions on the ability of the individual retirement plan account holder to receive a distribution of the benefits.

Fees and Expenses. The safe harbor creates two limits on fees and expenses charged to the individual retirement plan. The first limit is that fees and expenses for such plans may not exceed fees and expenses charged by the provider for comparable individual retirement plans for rollover distributions that are not subject to the automatic rollover provisions. The intent of this provision is to ensure that fees and expenses charged to individual retirement plans established with a mandatory distribution are not inconsistent with the marketplace. The safe harbor recognizes that some providers will charge a one-time fee to set up an individual retirement plan. However, under these limits, if a provider imposes no establishment or setup charge for its comparable individual retirement plans, it may not impose a charge on plans established for mandatory rollover distributions.

The second limit provides that fees and expenses related to the individual retirement plan may be charged only against the income earned by the plan, with the exception of setup fees for the establishment of the plan. Under this limit, the plan fiduciary may not choose a provider that charges fees on another basis, even if the provider charges are consistent with the manner in which it charges fees to other individual retirement plans.

Notice Requirements. Under the safe harbor, the plan must inform participants and beneficiaries of the plan’s procedures governing automatic rollovers, including an explanation about the nature of the investment product in which the mandatory distribution will be invested, and how fees and expenses relating to the individual retirement plan will be allocated. In addition, the disclosure must identify a plan contact for further information concerning the plan’s procedures, individual retirement plan providers, and the fees and expenses relating to the individual retirement plan. The contact person is expected to be able to provide an inquiring participant or beneficiary with specific information about the automatic rollover of their account balance.

Safe harbor relief is conditioned on furnishing this information to the plan’s participants and beneficiaries in a summary plan description or summary of material modifications in advance of an individual’s automatic rollover. Plan distribution materials (election forms, etc.) will also have to be updated. Code section 401(a)(31)(B)(i) requires the plan administrator to notify the participant in writing either separately, or as part of the notice required under Code section 402(f), that the participant may transfer the distribution to another individual retirement plan.

Can Plans Comply with Code Section 401(a)(31) without Complying with the Safe Harbor?

The proposed regulation makes clear that the safe harbor is not the only way in which to satisfy the requirements of 401(a)(31). For most plans, the safe harbor will be the most efficient and least risky approach to handling automatic rollovers.

What Should We Do Now?

Once the proposed regulation has been finalized (perhaps as soon as June or July of this year), plan sponsors should complete the following compliance steps before the effective date of the regulation (six months after the final regulation is issued):

• Amend your plan to implement the Code section 401(a)(31) rules (the DOL may issue further guidance that clarifies whether this must be done before the compliance date, or if it can be done as part of the EGTRRA remedial amendments).
  
  
• Determine whether you want to comply with the safe harbor provisions for mandatory rollovers.
  
  
• If you choose to comply with the safe harbor, choose a provider, or providers, and an individual retirement plan (or plans) that comply with the investment and fees and expenses provisions of the safe harbor. This is a fiduciary decision that should be properly documented. As a practical matter, it may be that there are not a lot of providers to choose from given the limits on fees and expenses imposed by the DOL.
  
  
• Update your summary plan description, or issue a summary of material modification, and update your distribution forms before you roll over a mandatory distribution for the first time.
  

FOR FURTHER INFORMATION, CONTACT:

Jason T. Froggatt, Seattle, (206) 628-7629, jasonfroggatt@dwt.com

This Employee Benefits Advisory is a publication of the Employer Services Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in employment law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

Copyright © 2004, Davis Wright Tremaine LLP.

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