Fortunately, plan sponsors can solve this problem by making mandatory distributions and using the automatic rollover rules of the Internal Revenue Code and the Employee Retirement Income Security Act (ERISA) to facilitate the process, according to a Drinker Biddle & Reath white paper, “The Benefits of Mandatory Distributions.”
“From what I’ve seen, some pan sponsors simply don’t pay attention to it, and therefore they let the smaller accounts just sort of build up in the plan,” Bruce Ashton, co-author of the white paper and partner in the Employee Benefits and Executive Compensation group at Drinker Biddle & Reath, told PLANSPONSOR.
Ashton said plan sponsors should be paying attention to these smaller accounts to save time and money, as well as reduce risk. Many recordkeepers base their fees on the number of participant accounts or on the average account balance. Retaining small accounts in a plan after participants have left employment increases the cost for all participants (or for the plan sponsor if it pays the recordkeeper’s fees). In addition, if the distribution of small accounts can reduce the participant count to fewer than 100 participants, it will also eliminate the expense of having to file a plan audit with the Department of Labor (DOL).
Not only do these small accounts cost the plan sponsors, but they also expand the administrative responsibilities for the plan and service providers in two ways: For one, having these small accounts means more 404(a)(5) participant disclosures must be sent out. This includes former employees, so long as they still have an account balance in the plan. Secondly, the plan sponsor and recordkeeper must keep track of these former employees and possibly engage in a search for them (see “Addressing the Issue of Missing Participants”).
The plan committee also retains fiduciary responsibility for the accounts of these former employees. Although the liability of exposure may be small because of the size of these accounts, there is still exposure, the white paper emphasized.
Plan sponsors should set up a procedure—perhaps annually—to review the accounts and find those with $5,000 or less, Ashton suggests. “I don’t think there’s a special magic to setting up this procedure,” he said. Rather, it involves simply having the recordkeeper set up a time to find the small accounts and notify the plan sponsor.
Internal Revenue Code Requirements
The Code normally requires that a participant provide their consent before his account is distributed. This gives the participant a chance to decide whether to roll the money to another plan or an individual retirement account (IRA), take a taxable distribution or leave the money in the plan. But in the case of small accounts, plans can proceed with distribution without the participant’s consent (under Code section 401(a)(31)).
Plan sponsors should keep in mind, however, this does not eliminate the need to send distribution election forms to former employees with small accounts, the white paper said. The election form should notify the participant that if he fails to provide an election, his account balance will be rolled over to an IRA, and if no election is made, the plan may distribute the money.
ERISA Safe Harbor
In order to make a mandatory distribution, the money in the participant’s account must be rolled over to an IRA if the vested balance exceeds $1,000 but is less than $5,000 (excluding rollover amounts). If the participant does not give instructions about how to distribute his money, it is the plan sponsor’s decision to choose the IRA provider and the investment vehicle.
Plan sponsors are protected in doing so by the fiduciary safe harbor from the DOL regarding the selection of providers and investments. If fiduciaries follow the requirements, they are protected from complaints by former participants. The safe harbor requirements are as follows:
- The rollover amount cannot exceed the $5,000 limit under Code section 401(a)(31);
- The account balance must be rolled over to an IRA offered by a bank, trust company or savings association, a credit union, an insurance company, a registered mutual fund or other entities authorized by the Internal Revenue Service to act as IRA custodians;
- The rolled-over money must be invested in a product that meets requirements for preservation of principal and providing a reasonable rate of return, consistent with liquidity, such as a savings account;
- The fees and expenses for the IRA, including investment expenses, must not exceed the fees and expenses charged by the IRA provider for comparable, non-automatic rollover IRAs; and
- The participant must have the right to enforce the terms of the IRA.
The white paper is available here.