Builders and Contractors Exchange
Weekly Bulletin: 07 Mar 2005
New Amendment Required For Most 401(K) and Pension Plans
By: Geoffrey Hemphill
Most qualified retirement plans (401(k) plans, pension plans, etc.) contain provisions that allow them to distribute the account of a participant who terminates employment with the company prior to retirement age if that account is less than $5,000. This relieves plans from the burden of maintaining small retirement accounts for ex-employees. Typically, the company would simply send a check to the employee unless directed to rollover the account into an IRA or another qualified plan.
In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"). Section 627 of EGTRRA established a new requirement that such involuntary cashouts of accounts greater than $1,000 must be paid in a direct rollover to an IRA if the Participant does not make an affirmative election to receive it in a direct rollover or in cash. This rule becomes effective on March 28, 2005. Therefore, the company can no longer send cash to the ex-employee unless he or she has elected that option. If no option is selected, the company must set up an IRA and transfer the money to that IRA account. In addition, EGTRRA §657 requires the plan administrator to give the participant notice of the option to take the cashout in cash or as a direct rollover to an IRA.
Essentially, companies that sponsor qualified plans have two options. If you want to keep the involuntary cashout amount at $5,000, you must amend your plan to require the transfer to an IRA. In the alternative, companies may elect to change the involuntary cashout amount to $1,000. Then the new rule would not apply.
The bottom line is that companies will have to weigh the administrative cost and inconvenience of maintaining small balances for terminated participants vs. the cost and inconvenience of setting up and transferring funds to IRAs for ex-employees. Either way, an amendment is probably necessary. For employers that use a prototype plan from a retirement plan vendor, your vendor should have addressed this issue by now. Check and make sure. If, on the other hand, you sponsor an individually designed plan, you must choose one of these options and make the appropriate amendment by March 28, 2005.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.