By Mike McWherter, JD
Chief Compliance Officer
PenChecks, Inc. / PenChecks Trust®
The Economic Growth and Tax Relief Reconciliation Act of 2001, better known as EGTRRA, was signed by President Bush on June 7, 2001. EGTRRA made significant changes to income tax, capital gains tax, and estate and gift tax laws. It also made important changes to ERISA and retirement plans. One of the more notable changes was allowing retirement plans to “force out” (aka “cash out”) terminated participants with a balance less than $5,000 and “roll” or transfer their balance into an Automatic Rollover IRA if the plan had adopted such a provision and certain other conditions were met.
Fast-forward more than 20 years and many, perhaps most, Defined Contribution plan sponsors have adopted a force out provision and routinely use it to help control plan costs and reduce their fiduciary liability. And while many things have changed in the retirement plan space over the past 20+ years, the $5,000 cap on force outs (not including prior rollovers) has not changed… until recently.
On December 29, 2022, President Biden signed the SECURE 2.0 Act into law. Like EGTRRA and the SECURE Act before it, the SECURE 2.0 Act makes a number of important changes to retirement plan law, including the first ever increase in the force out cap. Effective for force out distributions to Automatic Rollover IRAs made after December 31, 2023, the new limit will be $7,000. This change will be helpful to all plan sponsors, but especially those at or just over the 100-person participant count for purposes of plan audit requirements. More about that below.
A few things to note about the new $7,000 cap and what to do if your plan wants to take advantage of it.
First, as under prior law (EGTRRA) the $7,000 cap has no automatic increase/decrease trigger. It’s not indexed to inflation, the Consumer Price Index, etc. Meaning it will take another “Act of Congress” to change it. Depending on future circumstances that could be either a pro or a con, but it’s worth noting. Given the time span between initial enactment with a $5,000 cap and the increase to $7,000, I wouldn’t anticipate any change in the cap in the foreseeable future.
Plan Document Update
Second, plan document update and maintenance is required. As stated above, EGTRRA requires the plan sponsor to adopt a force out provision in order to use force outs as a feature of the plan. The same applies to the $7,000 cap in SECURE 2.0. Failure to timely adopt the required amendment could lead to either a plan document failure, an operational failure, or both, together with the accompanying penalties and costs of correction. Accordingly, be on the lookout for force out provision and other plan document updates from your document provider, and adopt the amendments for the appropriate plan-year end or other applicable deadline.
But wait! There’s more! (cue TV infomercial pitchman voice)
More Plan Document Updates
The lower threshold of $1,000 under Code §401(a)(31)(B) remains unchanged. So if your plan document says otherwise, you might want to change the plan forceout provision to include amounts below $1,000 and thereby avoid merely turning a plan’s lost/missing participant issues into uncashed check issues. By using an automatic rollover IRA for all balances below $7,000 you can also standardize your distribution process to save administrative costs.
But wait! There’s even more! (see TV infomercial pitchman voice above)
Other Document Updates
Document update and maintenance doesn’t end with only the plan document. Be sure to update summary plan descriptions, summary of material modifications, plan manuals, employee handbooks and other employee/participant-facing material such as employee benefit websites or intranets. Best practice is to have someone in the plan sponsor’s organization responsible for routine check-ins with the plan’s ERISA counsel or TPA (Third Party Administrator) to make sure legal/regulatory updates, plan documents and related materials are updated and in sync.
Last but not least, back to plan audits mentioned above. Plans with more than 100 participants are usually considered “large plans” and are required to have an annual audit. But there is the 80-120 rule exception to the audit requirement. Paraphrasing the DOL rule:
If your plan filed as a “small plan” last year and the number of plan participants is fewer than 121 at the beginning of this plan year, you may continue to file your Form 5500 using Schedule I as a “small plan” under the “80-120 Participant Rule.” This rule allows plans with between 80 and 120 participants at the beginning of the plan year to file the Form 5500 in the same category (“large plan” or “small plan”) as the prior year filing.
How are participants counted? The prior instructions were basically that you count anybody with a balance in the plan (whether active, retired or separated from service), as well as counting any beneficiaries of deceased participants receiving or entitled to receive retirement benefits.
The DOL has revised its Form 5500 instructions with respect to how one counts the number of participants in a plan. For plan years beginning on or after January 1, 2023 – meaning the Form 5500 would generally be due in 2024 – only participants with account balances at the beginning of the year are counted for purposes of requiring a plan audit. As the DOL states:
The counting methodology for defined contribution retirement plans will be based on the number of participants with account balances, rather than the current method that counts individuals who are eligible to participate even if they have not elected to participate and do not have an account in the plan. This change is intended to reduce expenses for small plans and encourage more small employers to offer workplace retirement savings plans to their employees. See: DOL Fact Sheet.
The increase in the force out cap to $7,000 together with the change in participant count methodology means that many “small plans” have the opportunity to remain small longer, thereby avoiding the expense of an annual audit. Likewise, some “large plans” with a significant number of non-participating or non-contribution receiving individuals have the opportunity to become or return to “small plan” status, thereby also avoiding the expense of an annual audit.
What’s the takeaway?
Review the number and balances of terminated participants, search for, locate and force out those with a balance less than $5,000 currently and less than $7,000 after December 31, 2023. And for 5500 purposes only count active participants with a balance in the plan at the beginning of the plan year. PenChecks is very good at searching for, locating and paying out or rolling over the balances of lost, missing or non-responsive participants. Give us a call. We’re here to help and know how.
Mike McWherter, JD is Chief Compliance Officer for PenChecks, Inc. and PenChecks Trust Company of America, a leader in outsourced retirement plan distribution processing and Automatic Rollover/Missing Participant IRAs and related services.
With over 30 years of combined legal, financial institution and ERISA plan provider compliance experience, he provides guidance and oversight for all compliance matters, supervises regulatory exams and audits, and coordinates between outside counsel, management and the board of directors.