The Internal Revenue Service's new rules for qualified retirement plans went into effect on March 28, but the ripple effect from the rules has yet to play out.

"We'll wait and see," said David Delgado, a partner at Crowe Chizek and executive in charge of the firm's benefit plans services group. "Everyone is mobilizing, all the providers are communicating with various plan sponsors, people recognize this is going to happen."

Until now, qualified retirement plans, particularly 401(k) plans and the like, have typically included provisions to automatically distribute the balance in a plan to a terminating employee where the balance is less than $5,000. In order to avoid the automatic cash-out, the employee has to opt for an alternative provision, such as a rollover to an IRA or another tax-qualified plan. The onus has been on the employee.

Under the new rules issued as part of the Economic Growth and Tax Relief Reconciliation Act of 2001, and described in detail in IRS Notice 2005-5, companies must choose from one of three options that place restrictions on involuntary cash-outs and provide for mandatory rollovers.

The first option is that companies can eliminate the involuntary cash-outs on plans with balances over $1,000. This option changes the automatic cash-out threshold from $5,000 to $1,000 and enables employers to keep accounts active for former employees who had at least $1,000 in the plan.

In addition, if a plan allowed an employee to roll over a balance from another tax-qualified plan, that rollover balance must now be included in determining the $1,000 threshold.

Option No. 2 allows the employer to cash out a balance of more than $1,000 from the plan and automatically roll that amount over into a pre-determined IRA investment. It will be up to the employer to contract with an IRA service provider, make information about that provider available, and execute the tax-free transfer of funds to the IRA on behalf of terminating employees.

It remains to be seen whether the big brokerage houses and other financial institutions will embrace the new opportunity to set up exit IRA accounts for these small amounts. "There's not a lot of enthusiasm on the part of financial institutions to take in these rollover amounts," said Eddie Adkins, a partner and compensation and benefits tax practice leader at Grant Thornton's national tax office in Washington. "From a financial institution perspective, they don't see a lot of great fees and business coming from this because these are small accounts."

Note that with either of these options, employees still have the opportunity to request that their tax-qualified fund balances be cashed out or rolled over to a tax-qualified account of their choosing, but now, by default, the balances of $1,000 and higher will no longer be automatically cashed out.

Option No. 3 enables employers to stop making involuntary cash-outs and to hold off on making immediate decisions as to which of the first two options to adopt. This gives companies more time to decide which option is more attractive and to put the new procedures into place.

The deadline for bringing plans into compliance is the last day of the first plan year ending after March 28. For calendar-year plans, Dec. 31, 2005, is the deadline.

Embellishing the new rules are safe harbor regulations issued by the Department of Labor last September, which set March 28, 2005, as the date for implementation, and which provide detailed explanations of the employers' responsibilities for tracking down missing plan participants. "The fear is that you reduce your mandatory cash-out provision to $1,000 and you end up holding balances and lose track of people who are tied to those balances," said Delgado.

Bill O'Malley, managing director in retirement resources with RSM McGladrey, also spoke of clients voicing the same concern. "I just spoke with a chief financial officer at a hospital and she's concerned about that. They are going to be very proactive at getting people to leave the plan voluntarily," he explained. "They're really going to step up their exit strategy with these people, but they are not going to set up an IRA rollover account."

O'Malley is finding that most clients are choosing the first option, instead of implementing the automatic IRA rollover. "Almost universally, clients are electing to reduce their cash-out limit to $1,000 and avoid dealing with the issue that way. For most clients I think that is probably the right answer."

The Department of Labor's safe harbor guidelines provide a clear indication of a company's responsibility to track down missing plan participants. Employers are expected to utilize basic search methods that are easy and inexpensive. If the amount of money remaining in an account warrants additional search, professional locator services can be utilized.

The safe harbor regs also provide guidance as to how to handle funds owned by missing former employees. If possible, an employer is to roll the money into an IRA. If an IRA can't be opened (if, say, the balance is too small), the money can be transferred into a federally insured bank account or a state's unclaimed property fund.

The accounting angle

Auditors don't seem overly concerned about the new rules increasing their burden. "Because it doesn't affect any of the audit work we're doing this year, I don't think that the accounting profession has really looked into it except for disclosure in the footnotes," said Marilee Lau, national partner-in-charge of the employee benefits audit practice at KPMG.

"If clients have decided that they aren't amending their plan and are going forward with the mandatory cash-out, we would have to follow procedures to make sure that they notify the individual, and if the individual says, 'No, I don't want my money,' follow through and make sure the money is put in an IRA," said Lau. She added that auditors will ask clients what they are doing if they can't find the former employees. "It's my understanding that they'll still set up the IRAs."

Most public accounting firms themselves will probably opt to choose Option No. 1 and change the cash-out rules to $1,000. Becky Miller, managing director in the national tax group at RSM McGladrey, said that, "It's kind of a non-issue." While there is a lot of turnover in the profession, it's unusual for an accountant to have a 401(k) balance under $5,000. Furthermore, she noted that for exiting employees who do have small balances in their accounts, "most people tend to want their money."

RSM has not set up an automatic rollover. "To the extent it comes up, it will be a matter of dealing with it on a one-to-one situation," said Miller.

For companies that decide to stop involuntary cash-outs over $1,000, the provisions of an existing plan need to be amended. Companies that chose Option No. 3 to postpone making a current change must make the amendment by the last day of the current plan year. Employee communications must also be prepared and distributed.

Companies that have decided to implement the rollover feature for cash-outs over $1,000 must enter into a written agreement with an plan provider, choose a default investment, amend the plan documentation, and immediately communicate the change to employees.

Whichever option is chosen, companies must ensure that no automatic payouts of more than $1,000 occur after March 27, unless employees elect in writing to receive the cash.

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