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Cash-Out rules Change on March 28, 2005
George L. Chimento
February, 2005
An amendment will be necessary for most qualified retirement plans, and must be
executed no later than the last day of the plan year that overlaps March 28, 2005
(i.e. by December 31, 2005 for calendar year plans). The amendment will be
retroactive to March 28, 2005, so you need to think through the issues before
that earlier date. Because the amendment will be fairly straight-forward, you may
as well adopt it by March 28, 2005, rather than waiting until the end of the year
deadline.
The background is that a law was passed several years ago (EGTRRA) which
affects “cash-out” payments. Most plans permit forced "cash-out" payments to
any terminated participant with a balance of $5,000 or less (disregarding rollover
accounts), even if he or she does not consent to the distribution. The law allows
this so that plans can eliminate small accounts of terminated employees for
administrative convenience.
As a practical matter, most terminating employees want their money if they leave
employment, so many plans will never have to make a forced cash-out payment.
But it is a helpful feature in the rare instance when a terminated employee cannot
be found or will not sign distribution paperwork.
As happens to many good things, Washington decided to make cash-outs more
complicated. EGTRRA says that if a cash-out exceeds $1,000, it has to be
deposited into an IRA in that person’s name. Although a plan could select other
qualified rollover vehicles, such as individual retirement annuities, most plan
administrators will use IRA’s as the default payment choice, simply because IRA’s
are readily available and the cost structure for the participant will generally be
less than with an individual retirement annuity.
Setting up and administering small IRAs, usually for people who cannot be located
or who will not sign paperwork, is no picnic. And there are fiduciary judgments
involved. Before transferring money to an IRA, the plan administrator must be
sure the IRA fee structure passes muster under Department of Labor regulations.
As a practical matter, there are two ways to comply with this new law:
1. The easy choice is just to reduce your plan’s cash-out limit from $5,000
to $1,000.
The new law does not apply to very small cash-outs ($1,000 or less). That means
if a terminated employee with more than $1,000 does not consent to a
distribution, you must keep it in the plan until the retirement date. But that’s not
such a big deal for most plans. As noted, terminated employees usually want
their money, so having to keep it in the plan for many years is a somewhat
academic concern.
2. The other choice is to administer your plan under the new rule, which
requires you to roll over cash-outs that exceed $1,000, even if the participant
is not cooperative in signing paperwork to open up the IRA account.
With Choice 2, the main factors to consider will be:
A/ Will your fund sponsor be willing to set up these IRAs for terminated
persons who are not cooperating in completing forms ? If your plan is
administered exclusively with a large mutual fund company or insurance company,
they will usually accommodate this new feature.
B/ What is the cost structure? Generally, these IRAs can be administered so
that the cost is charged to the IRA, without additional charge to your company or
plan. The Department of Labor regulations do not provide a bright-line standard,
but you must exercise fiduciary discretion when selecting the rollover IRA for these
types of mandatory payments.
C/ Will the IRA sponsor accept cash-outs of $1,000 or less? Even though the
law does not require rollovers of cash-outs this small, this might make plan
administration more simple if you intend to use this procedure for cash-outs
greater than $1,000. Why not get rid of the smallest balances, if the IRA sponsor
is willing to take them ?
Although the IRS has suggested plan language for the required amendment in
IRS Notice 2005 - 5, you will probably want to modify this to fit with your plan's
terms. Also, the IRS suggested language only addresses Choice 2, so a more
tailored amendment will be needed if you prefer Choice 1.
Finally, Notice 2005-5 is of great interest to sponsors of plans who don’t really
think of themselves as having to comply with all of the qualified plan rules. The
Notice is clear that this change applies to 403(b) plans and to plans of churches
and governments. The deadlines for church and government plans may be
extended for such entities, as described in the Notice, which may be accessed at
this link.
This memorandum is prepared and made available as a courtesy. Under the
ethical rules applicable to lawyers in some jurisdictions, it may be
considered advertising.
This article is not a substitute for specific tax or other legal advice directed to
your particular situation. It may not be used for the avoidance of tax
obligations (including penalties), and may not be relied upon as a legal
opinion of the writer or any member of the Firm.
Return to home page: theworkplace.biz
Cash-Out rules Change on March 28, 2005
George L. Chimento
February, 2005
An amendment will be necessary for most qualified retirement plans, and must be
executed no later than the last day of the plan year that overlaps March 28, 2005
(i.e. by December 31, 2005 for calendar year plans). The amendment will be
retroactive to March 28, 2005, so you need to think through the issues before
that earlier date. Because the amendment will be fairly straight-forward, you may
as well adopt it by March 28, 2005, rather than waiting until the end of the year
deadline.
The background is that a law was passed several years ago (EGTRRA) which
affects “cash-out” payments. Most plans permit forced "cash-out" payments to
any terminated participant with a balance of $5,000 or less (disregarding rollover
accounts), even if he or she does not consent to the distribution. The law allows
this so that plans can eliminate small accounts of terminated employees for
administrative convenience.
As a practical matter, most terminating employees want their money if they leave
employment, so many plans will never have to make a forced cash-out payment.
But it is a helpful feature in the rare instance when a terminated employee cannot
be found or will not sign distribution paperwork.
As happens to many good things, Washington decided to make cash-outs more
complicated. EGTRRA says that if a cash-out exceeds $1,000, it has to be
deposited into an IRA in that person’s name. Although a plan could select other
qualified rollover vehicles, such as individual retirement annuities, most plan
administrators will use IRA’s as the default payment choice, simply because IRA’s
are readily available and the cost structure for the participant will generally be
less than with an individual retirement annuity.
Setting up and administering small IRAs, usually for people who cannot be located
or who will not sign paperwork, is no picnic. And there are fiduciary judgments
involved. Before transferring money to an IRA, the plan administrator must be
sure the IRA fee structure passes muster under Department of Labor regulations.
As a practical matter, there are two ways to comply with this new law:
1. The easy choice is just to reduce your plan’s cash-out limit from $5,000
to $1,000.
The new law does not apply to very small cash-outs ($1,000 or less). That means
if a terminated employee with more than $1,000 does not consent to a
distribution, you must keep it in the plan until the retirement date. But that’s not
such a big deal for most plans. As noted, terminated employees usually want
their money, so having to keep it in the plan for many years is a somewhat
academic concern.
2. The other choice is to administer your plan under the new rule, which
requires you to roll over cash-outs that exceed $1,000, even if the participant
is not cooperative in signing paperwork to open up the IRA account.
With Choice 2, the main factors to consider will be:
A/ Will your fund sponsor be willing to set up these IRAs for terminated
persons who are not cooperating in completing forms ? If your plan is
administered exclusively with a large mutual fund company or insurance company,
they will usually accommodate this new feature.
B/ What is the cost structure? Generally, these IRAs can be administered so
that the cost is charged to the IRA, without additional charge to your company or
plan. The Department of Labor regulations do not provide a bright-line standard,
but you must exercise fiduciary discretion when selecting the rollover IRA for these
types of mandatory payments.
C/ Will the IRA sponsor accept cash-outs of $1,000 or less? Even though the
law does not require rollovers of cash-outs this small, this might make plan
administration more simple if you intend to use this procedure for cash-outs
greater than $1,000. Why not get rid of the smallest balances, if the IRA sponsor
is willing to take them ?
Although the IRS has suggested plan language for the required amendment in
IRS Notice 2005 - 5, you will probably want to modify this to fit with your plan's
terms. Also, the IRS suggested language only addresses Choice 2, so a more
tailored amendment will be needed if you prefer Choice 1.
Finally, Notice 2005-5 is of great interest to sponsors of plans who don’t really
think of themselves as having to comply with all of the qualified plan rules. The
Notice is clear that this change applies to 403(b) plans and to plans of churches
and governments. The deadlines for church and government plans may be
extended for such entities, as described in the Notice, which may be accessed at
this link.
This memorandum is prepared and made available as a courtesy. Under the
ethical rules applicable to lawyers in some jurisdictions, it may be
considered advertising.
This article is not a substitute for specific tax or other legal advice directed to
your particular situation. It may not be used for the avoidance of tax
obligations (including penalties), and may not be relied upon as a legal
opinion of the writer or any member of the Firm.
Return to home page: theworkplace.biz
