Tax Alert: Compensation And Benefits

Qualified retirement plans that provide immediate 'cash-out' distributions to a terminated participant if the vested benefit is $5000 or less will have to be amended to comply with Department of Labor (DOL) final regulations. The final regulations provide a safe harbor for fiduciaries of taxqualified pension plans that are required to rollover plan benefits into an individual retirement plan when a terminated employee fails to elect a distribution method. The final regulations are effective for rollovers of mandatory distributions made on or after March 28, 2005.

BACKGROUND

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), if a qualified plan provides for mandatory distribution of amounts under $5000 upon termination of employment, and if the participant does not consent to receive the distribution or elect to have the distribution rolled over into another qualified plan or individual retirement plan, the plan is required to transfer distributions of vested benefits between $1000 and $5000 to an individual retirement account (IRA). These provisions are contained in Section 401(a)(31)(B). Under prior law, a qualified plan was permitted to cash-out a terminated participant by sending a distribution check directly to the participant. Under the new rules, automatic rollover to an IRA is the default method for making cash-out distributions.

Now that final regulations have been issued, the rules requiring qualified plans to automatically transfer mandatory distributions between $1000 and $5000 to an IRA will apply to mandatory distributions made on or after March 28, 2005.

IMPLICATIONS

Virtually all qualified plans that provide for mandatory cash-outs must be amended to comply with Section 401(a)(31)(B) and the DOL safe harbor regulations no later than March 28, 2005, unless the IRS takes action to extend the deadline. In light of the upcoming deadline, plan sponsors should begin immediately to review and amend qualified plan documents, administrative practices, and distribution notices. Plan sponsors should also select institutions to provide the IRA and select investments under the IRA.

REQUIREMENTS FOR SAFE HARBOR RELIEF

The final regulation protects retirement plan fiduciaries from liability under the Employee Retirement Security Act of 1974 (ERISA) by providing a safe harbor in connection with two aspects of the automatic IRA rollover process ' the selection of an institution to provide the individual retirement plan and the selection of investments for such plans.

In order to obtain safe harbor relief, a plan fiduciary must satisfy certain conditions. Among other requirements, the final rule provides that the plan fiduciary must enter into a written agreement with the IRA provider that is enforceable by the participant and that specifically addresses the investment of rolled-over funds and the IRA fees and expenses. The written agreement must provide that the funds will be invested in an investment product designed to preserve principal. Fees and expenses must be comparable to fees and expenses charged by the IRA provider for IRAs that are not subject to the automatic rollover rules. The IRA provider must be a bank, credit union, insurance company, or a mutual fund.

The preamble to the regulations states that guidance from IRS and Treasury is anticipated prior to the effective date of the final regulations.

CLASS EXEMPTION

Simultaneously with the final regulation, the DOL issued a class exemption from the prohibited transaction rules of ERISA that permits certain plan sponsors to use their own services and products in connection with rollovers of cash-out distributions to an IRA from their own employees' retirement plan. Prohibited Transaction Exemption 2004-16 only applies if the fees, other than establishment charges, are limited to the income earned by the individual retirement plan. The class exemption will become effective March 28, 2005.

Ruth Wimer and Alice Kurt are members of Ernst & Young's Compensation and Benefits Group. They can be reached at [email protected] and [email protected].

Qualified retirement plans that provide immediate 'cash-out' distributions to a terminated participant if the vested benefit is $5000 or less will have to be amended to comply with Department of Labor (DOL) final regulations. The final regulations provide a safe harbor for fiduciaries of taxqualified pension plans that are required to rollover plan benefits into an individual retirement plan when a terminated employee fails to elect a distribution method. The final regulations are effective for rollovers of mandatory distributions made on or after March 28, 2005.

BACKGROUND

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), if a qualified plan provides for mandatory distribution of amounts under $5000 upon termination of employment, and if the participant does not consent to receive the distribution or elect to have the distribution rolled over into another qualified plan or individual retirement plan, the plan is required to transfer distributions of vested benefits between $1000 and $5000 to an individual retirement account (IRA). These provisions are contained in Section 401(a)(31)(B). Under prior law, a qualified plan was permitted to cash-out a terminated participant by sending a distribution check directly to the participant. Under the new rules, automatic rollover to an IRA is the default method for making cash-out distributions.

Now that final regulations have been issued, the rules requiring qualified plans to automatically transfer mandatory distributions between $1000 and $5000 to an IRA will apply to mandatory distributions made on or after March 28, 2005.

IMPLICATIONS

Virtually all qualified plans that provide for mandatory cash-outs must be amended to comply with Section 401(a)(31)(B) and the DOL safe harbor regulations no later than March 28, 2005, unless the IRS takes action to extend the deadline. In light of the upcoming deadline, plan sponsors should begin immediately to review and amend qualified plan documents, administrative practices, and distribution notices. Plan sponsors should also select institutions to provide the IRA and select investments under the IRA.

REQUIREMENTS FOR SAFE HARBOR RELIEF

The final regulation protects retirement plan fiduciaries from liability under the Employee Retirement Security Act of 1974 (ERISA) by providing a safe harbor in connection with two aspects of the automatic IRA rollover process ' the selection of an institution to provide the individual retirement plan and the selection of investments for such plans.

In order to obtain safe harbor relief, a plan fiduciary must satisfy certain conditions. Among other requirements, the final rule provides that the plan fiduciary must enter into a written agreement with the IRA provider that is enforceable by the participant and that specifically addresses the investment of rolled-over funds and the IRA fees and expenses. The written agreement must provide that the funds will be invested in an investment product designed to preserve principal. Fees and expenses must be comparable to fees and expenses charged by the IRA provider for IRAs that are not subject to the automatic rollover rules. The IRA provider must be a bank, credit union, insurance company, or a mutual fund.

The preamble to the regulations states that guidance from IRS and Treasury is anticipated prior to the effective date of the final regulations.

CLASS EXEMPTION

Simultaneously with the final regulation, the DOL issued a class exemption from the prohibited transaction rules of ERISA that permits certain plan sponsors to use their own services and products in connection with rollovers of cash-out distributions to an IRA from their own employees' retirement plan. Prohibited Transaction Exemption 2004-16 only applies if the fees, other than establishment charges, are limited to the income earned by the individual retirement plan. The class exemption will become effective March 28, 2005.

Ruth Wimer and Alice Kurt are members of Ernst & Young's Compensation and Benefits Group. They can be reached at [email protected] and [email protected].