“Are there any issues of which I should be aware as I add this provision?”
Michael A. Webb, Vice President, Retirement Practice, Cammack LaRhette Consulting, answers:
Yes, indeed, there are issues, mostly surrounding whether you utilize multiple vendors in your 403(b) plan. The automatic cashout provision, which allows for the involuntary lump-sum distribution of account balances of $1,000 or less to participants without their consent upon employment termination, and, optionally, the automatic rollover of account balances of $1,000.01-$5,000 to a designated IRA upon employment termination, can be an effective way of minimizing plan administration and related expenses, since such small accounts must be provided with all of the required disclosures (e.g. Summary Plan Descriptions, Summary Annual Reports, etc.) that larger account holders must receive. In addition, as you pointed out, people who maintain small account balances tend to become “lost” participants who cannot be located, since they tend not to be as proactive in updating their addresses with the plan sponsor/vendor as those with larger account balances. In addition, the purchasing power of a plan is diminished if too many small account balances exist, since average account balance is one of the primary factors that vendors utilize in their pricing model for providing services to the plan.
So why might implementing an automatic cashout provision be problematic in multiple vendor 403(b) plans? The primary reason is that the cashout threshold is at the PLAN level, as opposed to the VENDOR contract level. Thus, if I have $3,000, with Vendor X, and $2,500 with Vendor Y upon employment termination, I have a total of $5,500 in the plan and thus my balance is ineligible for automatic cashout. However, unless my vendors are sharing this information with one another, they may not be aware of this fact and initiate automatic cashout proceedings since the amount in each of their contracts is less than $5,000.
A second issue is that some vendor contracts may prohibit certain types of automatic cashouts (such as the $1,000.01-$5,000 automatic rollover) or may prohibit automatic cashouts altogether. This restriction does not necessarily mean that you cannot have a plan level automatic cashout provision, but may influence the type of provision you implement (e.g. perhaps only a $1,000 or less lump-sum distribution if all of the vendors can administer such a provision, or cashout provision language that states that cashouts are subject to the specific provisions of a vendor contract).
These issues add complexity to the implementation of an automatic cashout provision for multiple vendor 403(b) plans that are not generally present with 403(b) plans that utilize a single vendor (though a single provider can maintain multiple contracts with varying cashout provisions as well). Thus, multiple-vendor 403(b) plan sponsors may encounter some difficulty in implementing and administering automatic cashout provisions.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.