Rev. Rul. 2000-36: Plan may provide for direct rollover as the default

[Dave Baker]

The following article is from Sal Tripodi's TRI Pension Services web site ( http://cybERISA.com ) and is reprinted here with Sal's permission (copyright 2000 TRI Pension Services, all rights reserved).

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Plan may provide for direct rollover as the default method of making involuntary distributions in the absence of an affirmative election by the participant (added July 18, 2000).

A qualified plan provides for involuntary distributions of vested account balances of $5,000 or less, following termination of employment. There are no after-tax contributions in the plan. Pursuant to IRC §402(f), the plan first provides a notice to the terminated employee, which explains the rollover and withholding requirements. Under the current terms of the plan, if the employee has not affirmatively elected whether to take a cash distribution or to direct a rollover, the plan makes a cash distribution. The employer is now amending the plan to make the direct rollover the default distribution method. Under the amendment, if the employee fails to make an affirmative election within the 30-day minimum election period prescribed by law, the plan will rollover the involuntary distribution to an IRA. The plan administrator selects the trustee, custodian or issuer of the IRA. The default rollover is explained in the notice material provided to the terminated employee. In Rev. Rul. 2000-36, the IRS ruled that a plan may use the direct rollover as the default method of distribution. Pursuant to Treas. Reg. §1.401(a)(31)-1, Q&A-7, the plan must explain the default procedure. The IRS also ruled that the amendment of the plan to change the default distribution procedure from cash to rollover is not a cutback described in IRC §411(d)(6). A change in a default method of distribution does not eliminate any option available from the plan, it only changes the automatic method of payment that is made in the absence of an election among the plan's options.

Uses of the default rollover procedure. Why might a plan sponsor consider this approach? One reason may be the hassle of having an involuntary distribution outstanding for a long period of time because the participant doesn't cash the check. By using the direct rollover as a default, the plan transfers the funds directly in the IRA, and no check is issued to the participant. The plan satisfies its obligation to pay the benefit, and the participant can take the withdrawal from the IRA when he wishes. A default direct rollover may be a useful tool when dealing with missing participants as well, in particular when a defined contribution plan is terminated and, after taking reasonable steps, the plan is unable to locate several participants. Note that Rev. Rul. 2000-36 does not address missing participant sitations. The facts of this ruling deal solely with situations where the participant receives notice of the pending distribuiton, and an explanation of the right to elect cash or rollover, and the default rollover procedure if no affirmative election is made. However, IRS has stated at many employee benefit conferences that use of the rollover process is the IRS' preferred method of dealing with the accounts of missing participants under terminated defined contribution plans.
Title I of ERISA issues. The IRS notes in the ruling that DOL would treat the choice of the IRA trustee, custodian, or issuer as a fiduciary action. However, once the funds are rolled over to the IRA, the distributee is no longer a participant under the plan for Title I purposes, because the entire benefit has been paid from the plan. See the definition of participant in DOL Reg. §2510.3-3(d).
Default rollover may not occur before end of 30-day election period. Remember that Treas. Reg. §1.402(f)-1, Q&A-2, requires the §402(f) notice to be provided no less than 30 days before the distribution. Thus, the participant must be given at least 30 days to make an affirmative election between the cash distribution and the direct rollover. Only after the expiration of this minimum election period may the plan proceed with the default rollover.

[Guest EMC]

I understand the concept, but as a practical matter, will a bank permit an IRA to be set up FBO a participant who hasn't personally signed up for the IRA her/himself? If the participant is "missing," or non-responsive, why would a financial instituion want to take on an IRA with what has to be a small amount in it (has to be less than $5,000) and cause itself the administrative burden?