Recent regulations trigger a requirement that most employers with tax-qualified retirement plans amend their plans by March 28, 2005. Employers have long been permitted to distribute to an employee (i.e., “cash out”), without the employee’s consent, the employee’s retirement benefits if the value of those benefits is $5,000 or less and the employee has terminated employment. The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) amended section 401(a)(31) of the Code to require employers that cash out benefits greater than $1,000 and up to $5,000 to transfer these amounts to an IRA. The effective date of this provision was tied to the issuance of final regulations by the DOL, which recently occurred. Employers have less than six months to decide how to treat small amount cash-outs, amend their plans and act to limit potential fiduciary liability.

Overview
The recent regulations set forth a “safe harbor” procedure that an employer can follow when automatically transferring cash-outs greater than $1,000 and up to $5,000 to an individual retirement plan (an “IRA”) without the employee’s consent. The regulations also extend this safe harbor protection to cash-outs of $1,000 or less if the employer chooses to provide for the direct transfer of these amounts to an IRA. When EGTRRA amended section 401(a)(31) of the Code as noted above, it also amended section 404(c) of ERISA to generally relieve fiduciaries of responsibility if the automatic transfer is made in a manner consistent with the final regulations enacted by the DOL.

Action Required to Comply with the Code
Before March 28, 2005, employers need to determine how to address automatic small amount cash-outs and amend their plans accordingly. Employers generally have the following options:

  • Retain all amounts of $5,000 or less;
  • Automatically cash out amounts of $1,000 or less and retain or transfer to an IRA amounts greater than $1,000 and up to $5,000;
  • Automatically transfer all amounts of $5,000 or less to an IRA.

Employers that decide to automatically transfer amounts (up to $5,000) to an IRA should ensure that their procedures satisfy the safe harbor requirements of the regulations.

Action Required to Limit Fiduciary Exposure Under ERISA
Employers that automatically transfer cash-outs to IRAs can limit their fiduciary liability by complying with the safe harbor requirements in the regulations. The safe harbor requires employers to enter into a written agreement with an IRA provider and to provide an explanation to employees. The written agreement must limit the form of investments and must describe the investment goals and the fees charged to the IRA. The explanation to employees must be provided in the summary plan description or a summary of material modifications. The explanation must state that automatic cash-outs will be invested in an IRA designed to preserve principal, explain the fees and how they will be allocated and provide contact information so employees may obtain further information.

Although the safe harbor procedures set forth in the regulations are not the only way fiduciaries can satisfy their responsibilities under ERISA, it makes little sense for employers who seek to comply with the regulations to do anything but follow these procedures.

Conclusion
Employees with benefits of $5,000 or less frequently terminate employment without requesting distributions. Employers that automatically cash out these small amounts must take several steps within the next six months to comply with the new requirements. Please contact the attorney with whom you work to discuss your options and ways to implement your decisions.