401(k) Auto Rollovers: A Convenient Safe Harbor for Small Business Retirement Plans

OK – with a new year upon us it’s time to clean up that rusty old 401(k) plan at your small business….right?  Let’s say that you work in or own a small business, and are responsible for operating the company’s 401(k) plan.  To put it lightly, it’s probably a massive nuisance.

401(k) plans can be a wonderful benefit to your employees AND a great opportunity for you to put more money away for retirement in a tax deferred account.  But as you may now, operating a plan can be a real bear.

I’ll be covering the finer points of operating small business retirement plans throughout the year.  Today’s post will focus on what to do with departed employees.  Employees will come and go to and from your business over time (hopefully not too often), and it’s not uncommon for them to leave money they’ve accumulated in your company’s qualified retirement plan.


ERISA & Fiduciary Responsibility

As you probably know, departed employees always have the opportunity to pull their money from your plan after they leave, either directly or via a trustee to trustee rollover.  But many employees neglect to do so.  Whether it’s because they don’t know how, don’t care, or are simply lazy, it’s very common for departed employees to “accumulate” in your 401(k) plan, long after leaving the company for greener pastures.

As you also know, as the sponsor of a qualified retirement plan you have certain fiduciary responsibilities when it comes to managing the plan on behalf of your participants.  It’s for this reason – fear of repercussion – that many sponsors feel stuck when it comes to managing assets of employees who long ago left the company.

Fortunately for you, ERISA was not written with the sole intention of making your life hell.  There are six safe harbors written into the law that free you from fiduciary responsibility if you follow a few step by step instructions.  And one of them conveniently covers departed employees.


ERISA Safe Harbors: Auto-Rollovers

After employees leave your company and no longer contribute to your 401(k) plan, it can be a major chore keeping them on the participant roster.  You’re still required to send them participant communications like investment changes and fee disclosures, yet many times old employees simply disappear.  Keeping them on the books can be costly too – especially if you’re paying fees per participant.

Enter the auto-rollover.  Auto-rollovers allow retirement plan sponsors to automatically transfer plan assets of departed employees into an IRA if the participant has a balance of $5000 or less.  If they have a balance of $1,000 or less you can even write them a check, and aren’t even required to roll the funds into an IRA.

When doing so, you’re technically taking control of your participant’s assets and making an investment decision on their behalf.  And of course, you’ll always be required to act in the best interests of the participant.  Logistically this means that you’ll need to designate an institution to receive the rollover and decide how the rollover will be invested.


Qualifying for the Safe Harbor

Qualifying for the safe harbor means that you’ll be free from fiduciary responsibility once the funds are placed into an IRA.  Wipe your hands clean, clean the old employee from the participant roster, and forget about them.  Here are the requirements to qualify:

  1. The rollover must be made into an IRA or annuity offered by:
    • A state or federally regulated bank or savings association
    • An insurance company whose products are protected by a state guaranty association
    • A mutual fund company, or
    • Another financial institution eligible to offer IRAs under the U.S. Treasury Department regulations
  2. There must be a written agreement with the provider specifying how rolled-over funds will be invested and what the fees and expenses may be
  3. The roll over must be invested in a way that preserves principal and provides a reasonable rate of return.  Acceptable products include:
    • Money market funds
    • Interest bearing savings accounts
    • Certificates of deposit
  4. The investment vehicle must maintain adequate liquidity
  5. Fees and expenses charged by the IRA provider can’t exceed the fees charged for other IRA accounts
  6. Participants must receive a Summary Plan Description or Summary of Material Modifications before any auto-rollover takes place


Other Issues

The laundry list of requirements above will ensure that your actions qualify for the safe harbor and effectively relieve you of fiduciary duty once the rollover is complete.  Keep in mind, though, that your plan must still allow for auto-rollovers to take place in the first place.  If your plan document doesn’t allow for auto-rollovers, even though you might qualify for the safe harbor you’d still be in violation of your own plan document, which is a compliance problem of its own.

If you have ex-employees you want to roll out but your plan doesn’t allow it, don’t fret.  Adding this provision in an amendment can be done without too much hassle.  You’ll need to find a reputable third party administrator to ensure your plan stays compliant, but for most small business plans it shouldn’t be too costly (and to be honest, most small business plans already have auto-rollover provisions anyway).


Prohibited Transactions

Finally, it’s possible that an auto-rollover could trigger a prohibited transaction if done incorrectly.  If you, the plan, or your company gets some kind of remuneration from the IRA or annuity provider, you’d be making a prohibited transaction.  Remember, you’re still tasked with designating an IRA or annuity provider in the sole interests of your participants.  Any type of compensation that doesn’t benefit the participant would be a breach of your fiduciary duty.

Typically this would only come into play if you received some kind of referral fee in exchange for selecting a certain financial institution to hold the account.  By and large this is only an issue for companies who are in the financial services industry themselves.


In Practice

Recordkeepers servicing small business retirement plans are experienced and knowledgeable when it comes to auto-rollovers.  For high turnover businesses, it’s probably a good idea to audit your participant roster every year or every few years, and clean up any ex employees with balances under $5,000.  Unfortunately you will be required to keep ex-employees in the plan when they’ve accumulated more than $5,000.  But for those with less, the safe harbor provides a convenient way to clean up your participant list without the fear of stepping afoul of your fiduciary duties.

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  1. Pingback: ERISA Section 404(c): Another Way for Plan Sponsors to Limit Legal Risk - Above the Canopy

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