Encourage Retirees to take a Lump Sum Distribution

[Ananda]

A 401(k) plan for the first time has over 100 participants and unfortunately must meet the plan audit requirements. There are over 50 retirees  that have between $5000 and $10,000 in their account and if only a few of them withdraw their monies the plan would have less than 100 participants. The plan sponsor would like to force out or encourage these retirees to take a lump sum.  Are there any options available? It seems that the plan sponsor can contact these participants and remind them that they can take a lump sum or rollover to an IRA. I'm concerned that if the plan sponsor offers a cash or other incentive to take a lump and the retiree accepts it could be deemed self dealing with plan assets. Further if the employer recommends a lump sum or a specific rollover it could be deemed fiduciary investment advice Any suggestions? 

[EBECatty]

The plan can require mandatory distributions for terminated participants who have reached the later of age 62 or normal retirement age, regardless of account balance. Assuming some or all of the participants have reached such an age, this should help. 

[Ananda]

OK Thank-you. So it seems that the plan document would need to have language to require mandatory distributions for certain retirees. Without that language it seems the plan is bound by the $5000 lump sum payout rule.

[Bill Presson]

Also remember that the plan has to have more than 120 participants on the first day of the plan year to require an audit. That's anyone eligible (whether or not they have a balance) and anyone terminated with a balance of any size.

[Mike Preston]

5 hours ago, Bill Presson said:

Also remember that the plan has to have more than 120 participants on the first day of the plan year to require an audit. That's anyone eligible (whether or not they have a balance) and anyone terminated with a balance of any size.

For now. And don't forget discrimination issues. If the reason distributions are not required is because older hces want to leave the money in the plan you can't force out rank and file but fail to force out the owners.

[ESOP Guy]

On 10/7/2021 at 7:09 PM, Ananda said:

It seems that the plan sponsor can contact these participants and remind them that they can take a lump sum or rollover to an IRA.

So don't they send them distribution forms every year?  That seems implied in that.   Maybe I am reading too much into that sentence.  

I would send them forms every year.   My guess is if you put a form in front of them some will want the money if they are retired.   Most people take the money and run if you offer it to them is my experience.  

A more radical solution to this might be to split the plan based on division and some claim it can be done on last name.

If this is a problem as of 12/31/2021 going into 1/1/2022 the split would have to happen before 12/31/2021.  I am assuming the problem isn't as of 1/1/2021 as paying people in 2021 wouldn't help.  

[chc93]

7 hours ago, EBECatty said:

The plan can require mandatory distributions for terminated participants who have reached the later of age 62 or normal retirement age, regardless of account balance. Assuming some or all of the participants have reached such an age, this should help. 

For such terminated participants, especially ones with very large account balances (over $100K), how do you force a "mandatory distribution".... rollover to IRA, cash distribution, etc?

[ESOP Guy]

Your plan should have language that follows these rules as they are required to be in the plan.

https://www.law.cornell.edu/cfr/text/26/1.411(a)-11

I quote:

(4) Immediately distributable. Participant consent is required for any distribution while it is immediately distributable, i.e., prior to the later of the time a participant has attained normal retirement age (as defined in section 411(a)(8)) or age 62. Once a distribution is no longer immediately distributable, a plan may distribute the benefit in the form of a QJSA in the case of a benefit subject to section 417 or in the normal form in other cases without consent.

[Luke Bailey]

On 10/7/2021 at 6:09 PM, Ananda said:

I'm concerned that if the plan sponsor offers a cash or other incentive to take a lump and the retiree accepts it could be deemed self dealing with plan assets.

I've never opined on this and would be interested to see what others think, but as long as the cash is not coming from the plan, how is this self-dealing with plan assets? In Lockheed v. Spinks the Supremes said that an employer could condition an early retirement benefit on signing a release. Seems to me that offering cash to take your money would be the carrot side of the Spinks stick. Arguably it could be a breach of fiduciary duty, but that argument does not seem strong to me. Again, interested to see what others think on this.

[Patricia Neal Jensen]

Another suggestion:  Charge these terminated Participants an annual administration fee and make sure to tell them and remind them of this.  This is legal and motivates them to roll the money over or just take the distribution.

 

[BG5150]

Keep in mind what Bill said:  If the plan was filing as a small plan (either on an SF or Schedule I), they can continue to do so until the participant count is MORE THAN 120 on the first day of the Plan Year.

Still, I would send letters to those affected gently reminding them they can move their money.  Include either the paper form and the Special Tax Notice, or explain in the letter who to contact the provider to begin the withdrawal (a lot of platforms are going electronic-only, or at least electronic-preferred).

[Ananda]

On 10/8/2021 at 7:42 PM, Luke Bailey said:

I've never opined on this and would be interested to see what others think, but as long as the cash is not coming from the plan, how is this self-dealing with plan assets? In Lockheed v. Spinks the Supremes said that an employer could condition an early retirement benefit on signing a release. Seems to me that offering cash to take your money would be the carrot side of the Spinks stick. Arguably it could be a breach of fiduciary duty, but that argument does not seem strong to me. Again, interested to see what others think on this.

If a plan sponsor is providing a cash or other incentive to a plan participant to take a lump sum distribution, isn't this self dealing on the part of the plan participant/party in interest or a 406(a)(1)(D) violation i.e., using plan assets to receive a benefit? Isn't this similar to the concerns raised by the DOL when IRA holders received gifts from the bank or other financial institution for opening an IRA?.

[Luke Bailey]

3 hours ago, Ananda said:

If a plan sponsor is providing a cash or other incentive to a plan participant to take a lump sum distribution, isn't this self dealing on the part of the plan participant/party in interest or a 406(a)(1)(D) violation i.e., using plan assets to receive a benefit?

Ananda, I don't think so, because the assets being used are the employer's, not the plan's. The participant gets the full benefit. All the employer gets is a collateral benefit of reduced admin costs, which is what Spink (it's Spink, not Spinks as I incorrectly spelled it in prior post) addresses.

 

3 hours ago, Ananda said:

Isn't this similar to the concerns raised by the DOL when IRA holders received gifts from the bank or other financial institution for opening an IRA?.

No, for same reason. Issue with IRAs and bank freebies is owner/fiduciary using plan assets to get a material personal benefit. Here, the employer is using its own assets to get the employee to take exactly the same benefit he or she would have either way, just at a different time.

[Ananda]

On 10/12/2021 at 3:15 PM, Luke Bailey said:

Ananda, I don't think so, because the assets being used are the employer's, not the plan's. The participant gets the full benefit. All the employer gets is a collateral benefit of reduced admin costs, which is what Spink (it's Spink, not Spinks as I incorrectly spelled it in prior post) addresses.

 

No, for same reason. Issue with IRAs and bank freebies is owner/fiduciary using plan assets to get a material personal benefit. Here, the employer is using its own assets to get the employee to take exactly the same benefit he or she would have either way, just at a different time.

Luke But if the plan participant is getting a cash benefit from the employer to make a withdrawal doesn't the ERISA self dealing concern focus on the participant and not the employer. So in the IRA toaster example the IRA holder and not the bank should be concerned because the IRA holder is accepting cash or a "kickback" in a transaction involving plan assets. Similarly the plan participant employee is receiving a cash benefit (from the employer) in a transaction involving plan assets i.e., withdrawing plan assets from the plan. All these transactions could raise 406(b)(3) concerns. 

[Luke Bailey]

8 hours ago, Ananda said:

Luke But if the plan participant is getting a cash benefit from the employer to make a withdrawal doesn't the ERISA self dealing concern focus on the participant and not the employer.

Ananda, the participant is just taking and receiving his/her full benefit. There is no loss. They are not being induced to do anything untoward.

8 hours ago, Ananda said:

So in the IRA toaster example the IRA holder and not the bank should be concerned because the IRA holder is accepting cash or a "kickback" in a transaction involving plan assets.

The concern is that the IRA owner may be accepting a lower rate of return, e.g. a lower rate CD, to get the toaster. In this case, the participant is getting his or her entire benefit, without any loss.

 

8 hours ago, Ananda said:

So in the IRA toaster example the IRA holder and not the bank should be concerned because the IRA holder is accepting cash or a "kickback" in a transaction involving plan assets.

A participant's receipt of his or her benefit is not a prohibited transaction. See IRC sec. 4975(d)(9).

 

8 hours ago, Ananda said:

So in the IRA toaster example the IRA holder and not the bank should be concerned because the IRA holder is accepting cash or a "kickback" in a transaction involving plan assets. Similarly the plan participant employee is receiving a cash benefit (from the employer) in a transaction involving plan assets i.e., withdrawing plan assets from the plan. All these transactions could raise 406(b)(3) concerns. 

The participant is not a fiduciary, so 406(b)(3) could not apply.

[C. B. Zeller]

If the account balances are made up, either partly or entirely, of 401(k) deferrals, is offering additional cash a violation of the contingent benefit rule? 1.401(k)-1(e)(6)

[Luke Bailey]

On 10/15/2021 at 8:18 AM, C. B. Zeller said:

If the account balances are made up, either partly or entirely, of 401(k) deferrals, is offering additional cash a violation of the contingent benefit rule? 1.401(k)-1(e)(6)

No, because you're not conditioning the other benefit on making or not making a deferral, just on taking a distribution after the employee has terminated.

I think the DOL could say you are violating duty of loyalty, because even if you point the participant to equivalent, and in fact likely better and cheaper, IRA rollover options, you are encouraging them to leave the walled garden of your plan. But I don't see a prohibited transaction.

[Ananda]

On 10/14/2021 at 11:56 PM, Luke Bailey said:

Ananda, the participant is just taking and receiving his/her full benefit. There is no loss. They are not being induced to do anything untoward.

The concern is that the IRA owner may be accepting a lower rate of return, e.g. a lower rate CD, to get the toaster. In this case, the participant is getting his or her entire benefit, without any loss.

 

A participant's receipt of his or her benefit is not a prohibited transaction. See IRC sec. 4975(d)(9).

 

The participant is not a fiduciary, so 406(b)(3) could not apply.

 

[Ananda]

Thank-you for your views. I understand that an argument can be made that the mere receipt of a participants benefit is not a PT. However, the concern here is not the receipt of a plan benefit but the additional cash payout that is enticing the participant to receive the benefit. A DOL Regional Office raised these concerns pursuant to a DOL  investigation I was involved with years ago. Regarding 406(b)(3) the fact pattern I addressed is where the owner/plan administrator received a very generous cash payout offered by the plan trustee to take a distribution. However, if the participant is not a plan fiduciary the concern would be 406(a)(1)(D), where a participant/ party in interest is using plan assets, to obtain a benefit i.e., the cash incentive to take a distribution, at least this is the position of a DOL Regional Office. By the way, pursuant to this DOL investigation, although PT concerns were raised by the DOL regarding cash incentives to be paid to participants to take a lump sum, no PT penalties were imposed and instead the DOL focused on other PT issues.     

[Luke Bailey]

2 hours ago, Ananda said:

By the way, pursuant to this DOL investigation, although PT concerns were raised by the DOL regarding cash incentives to be paid to participants to take a lump sum, no PT penalties were imposed and instead the DOL focused on other PT issues.     

Good to know, Ananda. Thank you.

[C. B. Zeller]

On 10/17/2021 at 4:06 PM, Luke Bailey said:

No, because you're not conditioning the other benefit on making or not making a deferral, just on taking a distribution after the employee has terminated.

I'm not sure I agree, especially if the account consists solely of 401(k) contributions. The reg refers to other benefits conditioned directly or indirectly on the election to defer.

For example, you couldn't offer an incentive where the employer will give a $1000 cash bonus to any employee whose 401(k) balance is greater than $50,000 at the end of the year. Even though the cash incentive is contingent upon the account balance, not the election to defer, the only way you can get an account balance is if you made an election to defer. Therefore the incentive is indirectly contingent upon the election to defer, and prohibited under the rule.

Same thing, I think, in this case. You are eligible for the incentive if you elect a distribution during a particular time frame. The only way you could elect a distribution is if you have an account balance, and the only way you could have an account balance is if you previously made an election to defer.

[BG5150]

What is the penalty if this situation isn't kosher?

[Luke Bailey]

7 hours ago, C. B. Zeller said:

Same thing, I think, in this case. You are eligible for the incentive if you elect a distribution during a particular time frame. The only way you could elect a distribution is if you have an account balance, and the only way you could have an account balance is if you previously made an election to defer.

C.B., I almost included this in my earlier post, foreseeing the argument,  but then I thought, "No, no one will go there. It's too crazy."

Sure, I guess as an exercise in pure logic, disconnected from the real world, if the plan sponsor, at some point while the participant was still eligible to defer, told the plan's participants, e.g. in the SPD, "Hey, I just want you to know that if you defer into the plan, then someday, after you've separated from service and can take a distribution, I will offer you an extra benefit, like a $100 cash payment, to take a distribution of your benefit. So please, please, defer!" I guess you could also posit a situation where the employer would have a larger payment for larger accounts, which would make the argument for application of the no conditioning rule. On those facts, one can  make a case that the side benefit was indirectly conditioned on deferrals. But if you go back to the OP, those are not Ananda's facts. And even if they were, I would argue that the side benefit is conditioned on taking a distribution, not making deferrals. Moreover, (a) the rule (1.401(k)-1(e)(6), applies to "employee's" elections, and a participant eligible for distribution is generally a former employee, and (b) 1.401(k)-1(e)(6)(v) specifically says that loans and distributions are not treated as a benefit contingent on deferral just because the participant has to have deferred to be eligible for a distribution or loan.

7 hours ago, BG5150 said:

What is the penalty if this situation isn't kosher?

"Kosher" covers potentially a lot of ground, BG5150, but if you are talking about violation of the contingent benefit rule it is disqualification of the CODA.

[C. B. Zeller]

I don't see anything that says the other benefit has to be disclosed in the SPD, or even that the employee has to be aware of the other benefit at the time the election is made for it to be a contingent benefit. But I'll grant that is certainly the spirit of the rule, so taking that into account, consider that once word gets back to the current employees that the employer is paying out incentives to former employees with small balances, you could reasonably see somebody who's thinking of leaving in the near future decide to start contributing now, so that they can get that extra cash in a few years.

The regulation does say that the distribution of the participant's account balance is not a contingent benefit. But we are talking about a cash payment in addition to the participant's account balance. You could argue that since the cash payment is conditioned upon the distribution, and the regulation specifically says that a distribution of the participant's account balance is not a benefit conditioned on the election to defer, that this clause in the regulation "breaks the chain" and causes the cash payment not to be conditioned upon the election to defer. That is not an unreasonable argument, but the word "indirectly" in the regulation is pretty broad. I could see this going either way.

[Luke Bailey]

4 hours ago, C. B. Zeller said:

I could see this going either way.

C.B. Zeller, I think intellectually, i.e., in terms of logic, it could go either way, but assuming it's a modest sum, I can't get as worked up about it as I might some other issues. I'm pretty sure I would beat this if it came up in an audit. Might have to give ground to the agent on a better issue as a "gimme," however.