Automatic rollovers--consequences of lowering the cash-out limit to $1,000

[Everett Moreland]

I have written a memo to myself (see a later message in this thread for its text) listing the consequences of lowering the cash-out limit from $5,000 to $1,000 to avoid automatic rollovers. I would appreciate corrections and additions.

[jevd]

MEMORANDUM

TO: File

FROM: ERM

DATE: February 7, 2005

RE: Consequences of reducing the cash-out limit from $5,000 to $1,000 to avoid automatic rollovers

Matters not changed

• Spousal consent. The plan need not obtain spousal consent for a voluntary distribution of $5,000 or less or for a loan secured by benefits of $5,000 or less. 1.401(a)-20 Q&A-8(d) and Q&A-24(a)(1); 1.417(e)-1(b)(2)(i); and Notice 2005-5, Q&A-13.

• Restricted employees. The restricted employee rules do not apply to a voluntary distribution of $5,000 or less. 1.401(a)(4)-5(b)(3)(iv)©.

• Increasing the cash-out limit. The plan may later be amended to increase the cash-out limit to $5,000. 1.411(d)-4 Q&A-2(b)(2)(v).

Matters changed

• Investment responsibility. The plan investment fiduciaries retain investment responsibility for the benefits of participants remaining in the plan because of lowering the cash-out limit.

• Missing participants. The plan might have more missing participants.

• Current availability. The unavailability of payment forms other than a lump sum for benefits of >$1,000 to $5,000 might violate the current availability requirement. See 1.401(a)(4)-4(b)(2)(ii)©.

• Vesting on plan termination. Partially vested participants remaining in the plan because of lowering the cash-out limit will fully vest on plan termination.

• Disregarding service under IRC § 411(a)(7)(B). The plan will not be able to use the following safe harbors to disregard service under IRC § 411(a)(7)(B) where the participant delays, beyond the safe harbor period, receiving a distribution that could have been cashed out within the safe harbor period under a $5,000 cash-out limit:

"A distribution shall be deemed to be made on termination of participation in the plan if it is made not later than the close of the second plan year following the plan year in which such termination occurs." (1.411(a)-7(d)(4)(ii))

"For purposes of paragraph (d)(4)(i) of this section, a distribution shall be deemed to be made due to the termination of an employee's participation in the plan if it is made no later than the close of the second plan year following the plan year in which such termination occurs, or if such distribution would have been made under the plan by the close of such second plan year but for the fact that the present value of the nonforfeitable accrued benefit then exceeded the cash-out limit in effect under Sec. 1.411(a)-11©(3)(ii)." (1.411(a)-7(d)(4)(vi))

Where a participant's service for which the participant has received a distribution is not disregarded under IRC § 411(a)(7)(B), the participant's accrued benefit may be offset by the participant's accrued benefit attributable to the distribution, if the plan so provides. 1.411(a)-7(d)(6)(i).

• 401(a)(26) testing of former employees. Participants remaining in the plan because of lowering the cash-out limit and whose vested accrued benefits are $5,000 or less may not, for purposes of 1.401(a)(26)-4©, be treated as excludable employees under the rule in 1.401(a)(26)-6©(4). 1.401(a)(26)-4(d)(2).

• Forms 5500 and 5500-EZ; service providers' per participant charges; VCP fee. Participants remaining in the plan because of lowering the cash-out limit count as participants for purposes of:

• The differing rules for completing Form 5500 for large plans and small plans. A small plan has 99 or fewer participants at the beginning of the plan year (120 or fewer if the plan's Form 5500 was filed as a small plan for the prior plan year). Small plans:

• Are exempt from filing Schedules C (Service Provider Information) and G (Financial Transaction Schedules)

• File Schedule I (Financial Information--Small Plans) rather than Schedule H (Financial Information)

• Are eligible for exemption from the requirement to file an Accountant's Report

• The ability to file Form 5500-EZ.

• Service providers' per participant charges.

• The VCP fee, which generally is:

Number of participants

20 or fewer

21 to 50

51 to 50

101 to 500

501 to 1,000

1,001 to 5,000

5,001 to 10,000

More than 10,000 Fee

$ 50

1,000

2,500

5,000

8,000

15,000

20,000

25,000

[Guest Harry O]

Don't forget that you'll be paying more PBGC premiums since employees between $1K and $5K stay in the plan. Yuck.

[Everett Moreland]

Harry O:

Thank you.

[mbozek]

But there is no free lunch with automatic IRA rollovers which will cost plan sponsors a one time set up fee and a per head charge which will be more than the PBGC annual head tax (even if it is raised to $30 a year). According to one post the per head charge for automatic rollovers of one vendor is $50. Given the hassles of establishing the procedures for automatic rollover and the cost why should funds be transfered to an IRA?

[Everett Moreland]

mbozek:

I agree with you. We have not found an acceptable IRA provider, and are concerned that the NESTEG provision for automatic rollovers to be transferred to the PBGC will prevent acceptable IRA providers from surfacing.

[Belgarath]

I don't (yet) have strong feelings one way or the other. There are good arguments for amending to remove the required cash out payments. But to play Devil's Advocate and look at it from the other side...

Yes, there may be a one-time setup fee, and a charge per account. But the alternative may be to continue to carry a participant for years, with PBGC premiums if applicable, and "per participant" plan charges, which over time may add up to substantially more than the mandatory rollover fees.

The plan can provide that distribution fees will be charged to the participant's account, for a terminated "non-responding" participant. So you can get rid of this account forever at little or no charge, depending upon the IRA provider.

If you handle plan terminations, you will know that deferring the problem often compounds it. When you are terminating the plan 6 years down the road, and you now have 43 particpants to pay out minimal benefits when you COULD have done a mandatory rollover previously, you may wish you'd dealt with a little aggravation up front rather than a lot of aggravation later on. Because at that point, you now have the 4 mandatory search methods under FAB 2004-02 (for DC plans) and you'll ultimately end up, if they don't respond, by having to do largely the same thing - either set up an account, or have to mess with state escheat laws.

The whole thing is completely stupid anyway. The best solution, IMHO, is for all such benefits to be sent to the PBGC. They can collect interest on all funds to help reduce their deficit, and ALL participants would then have a single source where they could inquire to see if they have unpaid benefits. Plan administrators are happy, employers are happy, and drug companies that sell headache remedies will lose sales.

I just realized that someone reading the above paragraph might think that I'm saying this can be done. To clarify, of course it can't be done now - it's just what I'd like to see as a solution if the IRS, DOL, and PBGC could get together to solve this foolishness.

[Guest sarnold]

FYI, my firm will be offering an Auto IRA Rollover solution, very soon. We will not be charging a set-up or per account fee to the Plan Sponsor. Fees to the account holder will be well within reason, IMO. I will be happy to share details, when they are ready for release.

Information will be transmitted to us electronically by Plan Administrator, funds can be wire or check. Will be a very smooth process.

[Guest Pensions in Paradise]

Sarnold - when you say "fees to the account holder", what do you mean? Will you be charging the participant to maintain the IRA account? If so, do you currently charge a similar fee to your normal IRA account holders?

[MGB]

Harry O.,

The only ones that will stay in your plan are those that don't respond or don't want a lump sum if you replace the $1,000-$5,000 mandatory lump sum with an elective lump sum. Most likely people will still take it.

[Jim Chad]

I think I read that the DOL will let me charge the "per Particiapant" fee to terminated Particiapants, while the Employer pays the fee of those still employed.

Furthermore, I think I read that you can charge these terminated Participants a higher fee if there is a good business reason for it.

The time involved in taking the money out of the Participants account, would make me want to charge about $50 or $60/year. This is considerably higher than the $20 to $35/year I charge employed Participants.

Any thoughts on this idea?

[Guest Pensions in Paradise]

What are you talking about Jim? Are you asking in the context of a plan sponsor or an IRA provider? A plan sponsor can pay the administrative costs for active participants while deducting such costs from terminated participants' accounts, but the cost has to be allocated proportionately to all participants.

[Jim Chad]

To Pensions in Paradise ( by the way, I have wanted to ask you for years, Is that Hawaii?)

On Friday, I could not remember, but I found it today. Late 2003 The DOL Published FAB 2003-3. I haven't found a copy yet, But in the Corbel Newletter. This example is on Page 8. Terminated Participants. Many employers are willing to pay the plan's administrative expenses for active participants, but object to paying plan expenses related to a terminated participant who elects to leave his/her account in the plan. FAB 2003-3 provides that a plan may charge reasonable plan expenses to the vested accounts of terminated participants, regardless of whether the same or any such charges are assessed against the accounts of active participants. The DOL also indicates that a plan may charge such terminated participant fees pro rate or per capita to the terminated participant accounts and without regard to whether a terminated participant had the option under the plan terms at severence from employment to receive distribution of his or her account or to roll over the funds to another plan or to an IRA. See possible conflict with IRS below.

The column later talks about how the IRS says you cannot have a significant detriment to accounts of people who have severed employment. The IRS has mentioned that limiting investment options is a significant detriment. The article than says "However the Revenue Service also has indicated that disparate treatment does not in and of itself mean the plan is imposing a significant detriment provided the employer can demonstrate a valid business purpose for the disparate treatment. "

This is from NOv, 2003. Can anyone add anything to this?