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Guest Article

(Reprinted from The 401(k) Handbook, published by Thompson Publishing Group, Inc.)

Keeping Distributions Simple: IRS New Distribution Rules and Your Plan Document


by Martha Priddy Patterson

Although the IRS intended to simplify the minimum distribution rules for employers and participants, the proposed regulations replacing the 1987 proposed guidance may have the opposite effect on employers. By adding a multiplicity of distribution options based on the new rules, a plan administrator may end up facing a multitude of disputes with various retirees or their surviving beneficiaries. All too often these individuals - and sometimes, their attorneys - believe that because the law permits a distribution format, the plan must also permit it. Keeping the plan's distribution options simple - and communicating that simplicity - can save a great deal of time, money and effort for all parties, and serve the best interests of the participants and the sponsor.

For employer plans, the simpler the distribution process and the closer to the basic requirements of the minimum distribution rules, the less expense the plan and its participants will have to bear and the easier the plan administrator's work will be.

The Ideal - the Lump Sum Transfer to an IRA

The ideal distribution for both the plan and a departing plan participant is a lump sum transfer to the departing participant's IRA. At first glance, this may seem to be a callous attitude of "goodbye and good riddance." But there are very significant benefits to both the participant and the plan in this approach. The reality is that once plan participants separate from service, whether to retire or to move to another employer, the plan and the participant can have difficulties keeping track of each other.

While this sounds impossible in today's "wired" world, this world is also mobile and rapidly changing. Participants may move to a different country, marry, change their names - and even change their gender. ERISA places the burden on plan participants to alert the plan to their whereabouts, but few participants are aware of this responsibility. If the participant does not keep the plan informed of his or her whereabouts, the plan faces a difficult and expensive search to find that participant when benefit payments must begin.

Given today's dynamic and global business economy, participants who have departed may struggle to find the plan after a few years. Plan sponsors are almost as mobile and as likely to change their identity through sales, mergers and reorganizations. Given these communications issues alone, for the good of both the participant and the plan, both 401(k) administrators and the plan design should strive to encourage departing plan participants to roll over their 401(k) account benefits into their new employer plan or to an IRA.

Advantages to the Participant

The participant enjoys several advantages from taking his or her balance at departure. First, the 401(k) account can be easily and painlessly moved to either a new or existing IRA with very little effort on the part of the individual. The plan administrator can execute a trustee-to-trustee transfer or issue a check payable to the generic "Trustee of the IRA for Ms. Departing Employee." Also, by consolidating 401(k) plan balances with personal IRA savings and rollovers from other employer plans, the participant always knows where the retirement savings are located and can control investment options. Another advantage is that one large IRA offers the participant more economies of scale in choosing investments and money managers. With individual retirement investments, even (and especially) at large institutions, money talks - and the more the amount of money, the louder it speaks.

Avoiding the Escheat Officers

A lump sum rollover reduces the chances that the participant's account could become subject to escheat to the state. States generally provide that unclaimed money and property held by financial institutions and others are subject to reversion to the state treasury after a period of years.

State escheat officers have become vigilant in tracking unclaimed 401(k) accounts of individuals who are eligible to withdraw their accounts under the plan, especially those accounts in which the holder is age 701/2 and by law required to begin plan distributions. If the accounts remain unclaimed during the state's escheat period, which is seven years in many states, but as few as four in others, the escheat officer will demand the account from the 401(k) plan administrator. The law is unsettled on whether the plan administrator is required - or even permitted - to release the accounts to the escheat officers. At a minimum, the plan administrator will face legal expenses regardless of whether the account is retained in the plan or distributed to the escheat officer. Once the accounts are in the hands of the escheat officer, the participant may be able to reclaim the account, but only after going through a reclamation process. Clearly, both the plan administrator and the plan participant can experience a significant amount of administrative angst and will spend money fending off or reclaiming these "abandoned" accounts.

Limits on Plan Sponsors' Distribution Rights

Plan sponsors generally are severely restricted in their ability to "force" distributions from retirement plans. The plan may distribute retirement plan benefits without the participant's consent only if the lump sum value of the benefit is $5,000 or less and either the participant is otherwise eligible to receive a benefit or must receive a benefit pursuant to the minimum distribution rules applicable when a participant reaches age 701/2 or retires, whichever comes later.

Consequently, a plan sponsor cannot force a participant to take a 401(k) account balance when he or she separates from service. But the plan sponsor can design the plan to provide for the most streamlined types of payment forms. For example, unlike defined benefit plans, 401(k) plans can avoid offering a joint and survivor annuity payment to married participants. To do so, the plan simply must provide that upon the death of a participant who was married for one year or more, the surviving spouse will receive the full benefit immediately, so long as the participant has not elected any life annuity option under the plan. If there is no surviving spouse or the spouse has consented to another beneficiary, the payment must be payable to that beneficiary immediately.

Here the plan sponsor has some discretion. First, the plan can follow the requirements to avoid offering joint and survivor annuities. Second, the plan can provide the normal payment form as a lump sum payment option and limit the only other payment option to the minimum distributions rule required by law. The plan can limit the permissible beneficiaries to one named individual and a named alternate, should the first beneficiary not survive the participant. The plan can refuse to permit a trust to be the beneficiary of the account.

These actions will reduce the chances of the plan becoming embroiled in estate challenges to the validity of the inheriting trust or among competing beneficiaries of the plan. Avoiding estate challenges is critical because these disputes can be especially complicated, lengthy and personal, often offering the plan administrator an unwanted and unpleasant glimpse of the participant and his or her family. Often, such disparities compel the plan to interplead in the case to resolve its ERISA duties of protecting plan assets and ensuring that benefits go to the lawful beneficiary. Unfortunately, the plan's legal fees will be another drain on plan assets as well as the plan administrator's time.

All of these reasons argue for the "keep it simple" approach to 401(k) plan distribution alternatives. For those participants enjoying flexibility - and complications - the plan administrator has yet another reason to suggest and facilitate the participant's lump sum distribution to an IRA.

Martha Priddy Patterson is the director of employee benefits policy analysis with Deloitte & Touche LLP's Human Capital Advisory Services in Washington, D.C. Patterson is the contributing editor of The 401(k) Handbook.
Reprinted with permission from the March 2001 supplement to The 401(k) Handbook, ©Thompson Publishing Group, Inc., 2001. All rights reserved.

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