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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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