Mandatory Distribution Best PracticesSubmitted by LHD Retirement on April 18th, 2018
By Jess DeGabriele
As plan sponsors wrap up their annual plan coverage and discrimination testing, the updated census allows for a perfect opportunity to clean up their plan by conducting mandatory distributions of certain terminated participants with balances still in the plan. Where allowed by plan document, force out procedures can have several benefits for plans. For example, distributing small balances can simplify plan administration by reducing the number of tracked participants who require annual disclosures and notices, or possibly increase plan-level average account balances which could help improve vendor pricing metrics.
Mandatory distributions involve the forced distribution of terminated participant balances below a certain threshold, which is designated by plan document to a regulatory maximum of $5,000. Accounts between $1,000 and $5,000 must be rolled over into an IRA, and accounts less than $1,000 can be distributed via check, with the standard taxes applied. Plan documents can elect to have all accounts below $5,000 rolled over directly into an IRA, but it is typical to see accounts below $1,000 distributed by check.
To force terminated participants from the plan, the plan sponsor will first need to send the targeted participants a distribution notice with 30 days to elect their own decision on what to do with their funds. This notice should include information on the options available to them, such as roll over to an IRA or distribute into cash with any applicable taxes or penalties, and what will happen with their funds if they do not act by a deadline designated in the letter, that is, remitted to them via check or rolled over to an IRA. With this notice, plan sponsors should include distribution forms and disclosures such as the special tax notice.
Plan sponsors will also need to select an IRA trust provider for the accounts that end up being rolled over into IRAs. Many recordkeepers are happy to provide this service and there are third party trust providers available in the marketplace as well. When selecting the trust provider, plan sponsors should consider the cost to administer the IRA, the investment that the funds will be placed in, and the strength and reputation of the provider. Cost and the investment vehicle go hand in hand. Since the investment vehicle is a money market fund, the yield on the fund needs to be adequate to cover the administration costs of the new account. For example, if there is a $5,000 account rolled over into an IRA and money market vehicle yielding 0.50% and there is an annual administration fee of $40, then the account would lose $15 in the first year.
Ideally, a terminated participant will make their own election regarding their funds. However, for the ongoing administration and health of the plan, it is prudent to implement mandatory distributions. Ideally, a plan sponsor will include the force out process as a part of their termination process and provide an outbound participant with the notices and paperwork necessary to make an election at the time of termination.
Jess DeGabriele, CRPS®, is an Investment Strategist with LHD Retirement. He can be reached at firstname.lastname@example.org.
This information was developed as a general guide to educate plan sponsors, but is not intended as authoritative guidance or tax or legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation. In no way does advisor assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations.
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