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Optimal Plan Design for Using PenChecks Services

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GATED – Optimal Plan Design for Using PenChecks Services

by | Oct 1, 2024

You’ve heard us loud and clear. You know that using Automatic Rollover IRA services from PenChecks Trust® can help you and your clients save time and money. So let’s drill down a little further to explore the best plan set-up to take advantage of our Automatic Rollover IRA services.

It starts with a review of the plan document, specifically, provisions within the distribution section. Different documents use different labels: “Force-Out Provisions,” “Mandatory Distributions,” or “Involuntary Cash-Out Distributions.” But the effect is the same – removing the balances of terminated employees if they don’t timely respond to the distribution notices.

The ability to remove these balances without employee consent can lower fees, limit fiduciary risk and decrease operational errors. To fully capture these benefits (by using PenChecks services), focus on optimizing three specific areas within the document’s distribution section.

Maximizing Small Balance Force-Out Distributions

The first thing you will notice is that a plan is not required to remove small balances for employees no longer working for the employer. Only when this feature is explicitly selected can it be utilized to remove small balances without the employee’s consent.

Avoiding Operational Failures

To be clear, if the small balance force-out feature is explicitly selected, the plan must remove those small balances if the employee does not timely respond to the distribution notice. There is no employer discretion over when or to whom the feature applies if it is selected in the plan document.

For example, the employer cannot allow the owner’s daughter to leave her small balance in the plan when she returns to college but force-out the small balances of other seasonal employees. In addition, force-out distributions cannot be completed in one year but then forgotten in the next year(s).

Failure to timely process these force-out distributions results in an operational error because the administration of the plan is not following the terms of the document. If you find that you have plans in this situation, a potential correction is to complete the force-out distribution process as soon as possible.

We recommend that employers not only elect small balance force-outs, but that their service providers timely process these distributions on a regular basis.

Increasing Threshold to $7,000

The threshold for determining a “small balance” increased from $5,000 to $7,000 for distributions occurring after December 31, 2023. You can operationally take advantage of the increase right now – before any plan amendment. For example, a plan has employees who left the company years ago and have current balances between $5,000 and $7,000. You should re-send the distribution notice to those employees and, for any who don’t timely respond, send their balances to an automatic rollover IRA.

The deadline for amending the plan to the higher threshold is no earlier than December 31, 2026. This extended deadline is due to the threshold increase being part of SECURE 2.0 law changes.

You should review the plan document to make sure an amount lower than the old $5,000 threshold was not selected. Look for a title similar to “Amount limit,” “Lower Involuntary Cash-Out Distribution Threshold,” or “Maximum force-out amount.” If a plan has a lower threshold, you will have to discuss with the employer whether to operationally raise that threshold to the new $7,000 limit.

We recommend operationally using the new limit of $7,000 before amending the plan. Many document providers have yet to prepare a SECURE 2.0 amendment and there is no reason to delay receiving the benefits of the increased threshold.

Excluding Rollover Contributions

The force-out distribution of a “small balance” can be higher than $7,000 if the balance includes rollover contributions. In reviewing the plan document, look for a title similar to “Application of Rollovers,” “Treatment of Rollover Contributions,” or “Excluding Amounts Attributable to Rollover Contributions.” An employer may exclude rollover contributions in determining if the balance exceeds the threshold limit, assuming the threshold limit is $1,000 or more.

For example, Victoria had a $6,000 balance in her old employer’s 401(k) plan which was transferred through auto-portability to her new employer. It doesn’t work out at her new employer and Victoria quits after accumulating $5,500 in deferrals and matching contributions. Assuming the new employer excludes rollover contributions when determining force-out distributions in the plan document and Victoria doesn’t timely respond to a distribution notice, the entire $11,500 may be transferred to an auto rollover IRA.

We recommend excluding rollover contributions in determining the threshold limit. In summary, excluding rollovers, increasing the threshold limit and timely processing small balance force-out distributions helps your clients reduce fees, fiduciary risk and operational errors.

Utilizing the Automatic Rollover IRA for Balances of $1,000 or Less

The law requires using an automatic rollover IRA for balances exceeding $1,000, but the safeguards of using auto rollover IRAs also apply to small balances of $1,000 or less. Indeed, using auto rollover IRAs for these smallest balances can prevent fiduciary risk for the employer and unfavorable tax consequences to the employee.

Despite these advantages, many plans still require force-out distributions of $1,000 or less to be paid via check. This may be the greatest cause of uncashed checks and missing participants. To avoid issues involved with uncashed checks and missing participants, the automatic rollover IRA feature should be selected in the plan document for balances of $1,000 or less.

In the distribution section, look for an option allowing you to apply the automatic rollover provisions to certain balances. Be careful to lower the amount subjected to automatic rollover rules, NOT lower the threshold limit for force-out distributions generally. The option may be a blank line into which you enter a number (e.g., “if over: $0” or “at least: $.01”). Or the option may be a check box option to apply automatic rollover rules to all small balances – including those below $1,000.

We recommend using the automatic rollover IRA feature for any balance $7,000 or less (including balances of $1,000 or less) to alleviate fiduciary liability and unfavorable tax consequences.

Leveraging Force-Out Distributions at Normal Retirement Age

It may be time to consider a rarely used force-out distribution option due to recent law changes. Based on the complexity added to the required minimum distribution (RMD) process, employers should consider distributing participants’ balances without their consent when they have terminated employment and reached the plan’s normal retirement age (or age 62, if later).

Doing so reduces exposure to operational errors or potential excise taxes associated with the RMD process. The ability to force-out terminated employees at normal retirement age without their consent can be found in the plan document under a section with a title like, “required distribution at normal retirement age,” “distribution upon attainment of stated age,” or “force-out of a terminated participant’s account balance.”

We recommend using force-out distributions at normal retirement age to avoid the burdensome RMD process.

Conclusion

These plan design features can be used by both new and existing plans. It is not too late to act if the plan is already established. All of our recommendations can be added to the plan document with a simple amendment. No need to worry about the anti-cutback rule as force-out provisions are not considered protected benefits.

Optimizing the design and operation of your client’s plans to take advantage of PenChecks’ services results in benefits for both you and your client. Utilizing these recommendations and our services results in an efficient process for you – allowing you to focus on higher value-add activities. Moreover, your clients will benefit from lower fees, limited fiduciary risk and decreased operational errors.


About the Author

Brian Furgala, Esq., CPC, QPA is Senior Director, Retirement Services Strategy for PenChecks, a leader in outsourced retirement plan distribution processing and Automatic Rollover/Missing Participant IRAs and related services. His broad experience as an ERISA attorney and senior executive for several leading retirement plan service providers gives him a unique perspective on the industry.

The views expressed in this article are those of the author and do not necessarily represent the views of PenChecks Trust®, its subsidiaries or affiliates.


PTCA-2024087

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