May a plan restrict distributions to direct-deposit?

[Peter Gulia]

A retirement plan's sponsor would like to amend its ERISA-governed plan to restrict distributions to preclude a check and allow only a direct deposit to a distributee's bank or other financial institution account?

Would such a provision be contrary to any required provision of ERISA's title I?

Would such a provision tax-disqualify the plan under Internal Revenue Code section 401(a)?

Why?

[Kevin C]

What would they do with participants who do not have a bank account?  Some of our clients have a significant percentage of people who do not have bank accounts.  The companies that direct deposit paychecks help them get one of the prepaid credit cards for their paychecks.  Our experience has been that those cards refuse to accept ACHs of plan distributions.

[jpod]

I think you can do it, if (a) it is consistent with the terms of the plan, and (b) you comply with 401(a)(14) and 401(a)(9) for those individuals who have not established direct deposit.

[david rigby]

Currently in the process of doing a plan termination and we suggested Peter's approach of all direct deposit.  That suggestion was rejected precisely because of Kevin's point.

[Peter Gulia]

Kevin C, jpod, and David Rigby, thank you for your helpful thinking.

 

Just to consider the idea in a way that might bypass a no-bank-account problem, imagine this:

 

The plan provides a normal-retirement-age distribution that is logically consistent with ERISA § 206(a) and IRC § 401(a)(14), and always results in a distribution no later than age 69.  The plan does not allow a participant to delay the distribution.  (Just for discussion, let’s leave aside the problem of what provisions to make for later accruals.)

 

The plan provides that a failure to furnish sufficient direct-rollover or direct-deposit instructions is a deemed election of a rollover into a default Individual Retirement Account.

 

Would this result in a regime under which (leaving aside a 70-something’s accruals) the plan’s administrator never need write a check?

 

Would it work?

[Kevin C]

Peter,

I don't think what you describe would be considered to be acting solely in the interests of participants and beneficiaries (ERISA 404(a)(1)).  I also think it would be very likely to have the claims procedure be considered to not be reasonable under 2560.503-1(b)(3).

Also, what do you do with a participant or beneficiary who doesn't have a valid SSN?  I haven't heard of any auto rollover company that will accept a rollover without a valid SSN.

 

[FPGuy]

If the rollover IRA was free of charges or the costs above what participants are charged, if anything, for a "normal" direct deposit distribution were paid by the employer, could it pass muster? By the way, as a general matter, what does one do with a distribution to a recipient who lacks a valid SS#?

[Peter Gulia]

Kevin C and FPGuy, thank you for your observations.

 

Even when a plan’s sponsor and the plan’s administrator are the same person, ERISA sets a distinction between creation and fiduciary roles.  An administrator administers the plan on the governing documents delivered to the administrator.  A plan’s sponsor creates a plan without an ERISA fiduciary’s responsibility.

 

The statute tells a plan’s administrator not to follow a document’s provision to the extent that it is inconsistent with ERISA’s title I or title IV.  But I don’t see in those statutes a specific command about a retirement plan’s manner of payment.

 

Thank you for helping me think about whether a plan’s provision might be a claims procedure that might inhibit or hamper the initiation or processing of a claim for the plan’s benefit.

 

A Federal court might treat a complaint about a default IRA as implausible if the complaint suggests the plan specified or the fiduciary selected the IRA following 29 C.F.R. § 2550.404a-2(c).  And an IRA’s holder can exit the IRA whenever she wants to.

 

In my experience, financial institutions’ systems designed to look for a taxpayer identifying number will process any kind—SSN, ITIN, EIN—that could be an IRS-assigned number.  One who lacks a Social Security Number can get an Individual Taxpayer Identification Number.

[loserson]

Having trouble understanding the play here.  Why are they doing this?

Is this just a cost question?  Does the plan not already charge an admin fee for distributions?  I mean, maybe just charge enough to cover reasonable costs of a distribution check?

I am concerned at the idea that they would be getting "consent" to an IRA by locking away people's distributions unless they agree to it.  We might be talking about people unable (or unwilling) to get bank accounts, so their options are get an IRA or else no distribution.  I think the consent in that case could be a little hollow.  And if your defense is "well they could just get a check from the IRA" then why is the plan making them do this?  Why go through the annoying process of a rollover just to get a check?

Treas Reg 1.411(a)-11(c)(2) has distribution consent requirements.  You might take a look there and think about any implications of deeming folks to have consented to an IRA rollover under various scenarios.

Treas Reg 1.401(a)(31)-1, Q&A-9, says that you must allow partial direct payment to distributees alongside partial rollover but does not address direct payment method.

If there is no reasonable cause for this rule, then it seems like you are obstructing people from taking distributions, which for sure sounds like fiduciary duty territory.

IRAs have gotten really good lately, and a smart investor can get really cheap and good index funds.  And people are way better off not getting taxed, and they are way more likely to leave a rollover in a tax-advantaged account.  So it's not crazy in principle.  But I am concerned that functionally this rule will keep people from their distributions.  And if the employer is saying "non-IRA bank account ACH is okay, just no direct checks" then we lose the paternalism argument entirely.

[Peter Gulia]

loserson, thank you for your helpful observations.

No one is yet doing anything.  And it isn’t my idea.  Rather, a business wants to evaluate the idea.  (I understand that some find the idea unseemly.  I often give clients business, practical, and even moral advice that goes beyond technical legal advice.)

Thank you for your pointer about 26 C.F.R. § 1.411(a)-11(c)(2).  But doesn’t -11(c)(4) make a consent unnecessary once the participant has attained the later of age 62 or normal retirement age?

My query isn’t about a fiduciary interfering with a participant’s right to get what the plan provides; rather, it’s about what the plan provides.  The key question is whether a plan’s proper provisions may limit the manner of payment.  Or whether a participant somehow has a right that the plan’s manner of payment not be too burdensome.

Again, it’s just an idea.  These BenefitsLink thoughts might persuade a business to abandon the idea.

[loserson]

I guess I am interested why a plan would want to do this.  If it's a cost thing, can't they just increase their fee for a distribution check?

[Mike Preston]

In the hopes that the following furthers the discussion instead of hijacking it.......

I have run into some strange practices from organizations that think they can impose their own will, ERISA be damned.  For example, one household name investment company (let's call it "Investment Company A") recently tried to insist that they could not do direct rollovers to any IRA that wasn't an Investment Company A IRA.  They were forcing participants to establish an IRA with Investment Company A, direct rollover to that IRA and then "allowing" the individual to rollover/transfer to an IRA with another company.  I have no idea what fees they attempted to wring out of the participants that went along with the mandate.  Made me wish there was a whistle blower reward of some kind that would apply.  They know that very few will have an ERISA consultant/expert willing to suffer through an attempt to reach a non-monkey on the participant's behalf.  That would generally make it more expensive so they know most will just go along.  

[Peter Gulia]

loserson, it's not about incremental expense in processing checks rather than direct deposits.

Rather, a retirement plan's sponsor has had some bad experiences with a distributee presenting the same check twice.  While one would like to think the plan trustee's drawee bank should charge its drawer's (the trustee's) bank account only once, what I heard is that it's not so easy.  (My task does not include getting into the negotiable-instruments and payments law.)  The idea is that direct deposits might decrease the frauds.

[Mike Preston]

Change Trustee.  Much better than exposing plan to a charge of violating ERISA. Not a flip response.  I mean it.

[Peter Gulia]

Thanks.

The plan's sponsor is the trustee.  They tried to get a bank or trust company to serve, but none wants this plan's business.  (There might be other reasons for that.)

 

[loserson]

On 5/8/2019 at 4:35 PM, Fiduciary Guidance Counsel said:

loserson, it's not about incremental expense in processing checks rather than direct deposits.

Rather, a retirement plan's sponsor has had some bad experiences with a distributee presenting the same check twice.  While one would like to think the plan trustee's drawee bank should charge its drawer's (the trustee's) bank account only once, what I heard is that it's not so easy.  (My task does not include getting into the negotiable-instruments and payments law.)  The idea is that direct deposits might decrease the frauds.

Ah, I see.  Can you handle by making trustee indemnify the plan for its failure?  Or doing an amendment to the trust agreement to make them indemnify?  Or switching to another trustee?

Edit - Just saw your subsequent comment that sponsor is trustee

[loserson]

On 5/8/2019 at 5:26 PM, Fiduciary Guidance Counsel said:

Thanks.

The plan's sponsor is the trustee.  They tried to get a bank or trust company to serve, but none wants this plan's business.  (There might be other reasons for that.)

I can't recall ever advising a qualified plan that used the sponsor as trustee, but thinking more about this, the decision to use the employer as trustee would be a fiduciary decision.  And if the plan sponsor is bad at being trustee and handling plan assets in the way a typical trustee would be able to, wouldn't this potentially be a fiduciary failure?

Have not looked specifically at this issue before, but it seems like maybe pushing the fiduciaries to find a professional trustee is a better step than figuring out if they can barricade unbanked participants from taking distributions.  At the very least, recommending a better trustee is CYA for you as their counsel.

I also think "my employer won't write me a check for my 401(k)" is the kind of thing that (1) individuals are more likely to complain to EBSA about and (2) EBSA is likely to consider worth a look.

[Peter Gulia]

loserson, thank you for your further observations.

Those points (and more) were in my advice.