Governmental Plans Update (2003-2004) (Posted on September 9, 2004 by Carol V. Calhoun)

1. The following specific forms of benefit:
   1. Single life annuity to the member with no survivor benefit
   2. Joint and survivor annuity where the spouse (other than a same-sex spouse) is the survivor (provided the survivor benefit is not greater than 100% of the member’s benefit);
   3. Joint and survivor annuity where the survivor is a non-spouse or a same-sex spouse and the age difference between the member and the survivor is no greater than 10 years (provided the survivor benefit is not greater than 100% of the member’s benefit);
   4. Annuities with period certain protection (provided certain restrictions on length of guaranteed period are not exceeded);
2. COLA Changes if the increase is pursuant to
   1. Indexed benefits, if calculated under one of the following methods:
      1. An annual percentage increase that does not exceed the annual percentage increase in a Bureau of Labor Statistics (BLS) general cost-of-living index or a cost-of-living index for a specific population or geographic area; or
      2. A percentage adjustment based upon an increase in the compensation for the position held by the member at retirement.
   2. Flat percentage increase that cannot exceed index: The final regulation allows for a percentage increase at a specified time (e.g. at specific ages). However, the increase may not exceed the cumulative permissible increase in the permissible index since the annuity start date or the date of the most recent previous percentage increase, if later.
   3. Flat Percentage Increase of Not Greater than 5% – In a later part, the final regulation also provides that, in the case of an annuity provided by a Code section 401(a) defined benefit plan, payments may be increased by a constant percentage applied not less frequently than annually at a rate not to exceed 5% per year.
3. Increase Based on Actuarial Gain – In the case of an annuity provided by a Code section 401(a) defined benefit plan, an increase can permissibly result from dividend payments or other payments that result from actuarial gains but only if
   1. the actuarial gain is measured no less frequently than annually;
   2. the payment is either made no later than the year following the year in which the actuarial experience is measured or paid in the same form as the payment of the annuity over the remaining period of the annuity;
   3. the actuarial gain taken into account is limited to the actuarial gain from investment experience;
   4. the assumed interest used to calculate such actuarial gains is not less than 3%; and
   5. the payments are not increasing as a constant percentage.
4. Changes based on changes in family circumstances, if based on one of the following:
   1. An increase in a member’s annuity to the extent that a reduction was necessary to provide a survivor benefit, if the survivor has died or is no longer the member’s beneficiary pursuant to a qualified domestic relations order.
   2. A pop-up in payments in the event of a divorce.
   3. A beneficiary’s election to convert the survivor portion of the benefit to a lump sum.
   4. Subject to certain conditions, a “period certain only annuity” can be changed at any time.
   5. Subject to certain conditions, an annuity can be changed to a qualified joint and survivor annuity upon marriage in retirement.
   6. Certain payments to “children” can be considered payments to the spouse for the purposes of the final regulation, provided the payments revert to the spouse when “childhood” ceases. For these purposes, a disabled child is considered a “child” so long as the disability continues.
   7. Ancillary benefits payable to a survivor upon the death of a member in retirement (provided the benefits are not part of the member’s benefit being annuitized).
   8. In the case of an annuity provided by a Code section 401(a) defined benefit plan, a final payment to a survivor that does not exceed the actuarial present value of the member’s accrued benefit at the time of retirement over the total payments made before the death of the member (a “declining reserve annuity”).
5. Increases in benefits pursuant to a plan amendment.

1. Increases paid pursuant to COLAs/purchasing power protection provisions/thirteenth checks provisions not coming within any of the foregoing.
2. Joint and survivor annuities where the survivor is a non-spouse or same-sex spouse more than 10 years younger than the member, unless there are restrictions based on the life expectancies of the member and spouse.
3. Some period certain annuities, depending upon the age of the member at retirement.
4. Any form of survivor benefit which is greater than the benefit being paid prior to the member’s death (unless the payment is permitted under one of the exceptions provided in the final regulation, e.g., a permitted COLA).

1. All plans: With respect to any non-grandfathered distributions for calendar years 2003, 2004 and 2005, such distributions which do not satisfy the final regulation will permissible provided “the distribution option satisfies [Code section 401(a)(9)] based on a reasonable and good faith interpretation of the provisions of [Code section 401(a)(9)].”
2. Governmental plans:
   1. Benefits in the plan before April 15, 2002 and not amended thereafter: The temporary relief for distributions described in a. is extended “to the end of the calendar year that contains the 90th day after the opening of the first legislative session of the legislative body with the authority to amend the plan that begins on or after June 15, 2004, if such 90th day is later than December 31, 2005.”
   2. Amendments adopted on or after April 17, 2002, but before June 15, 2002: These amendments do not receive the delayed effective date provided in paragraph (1). Moreover, if a benefit form was previously subject to the delayed effective date, the delayed effective date may be lost by amendments on or after April 17, 2002. However, forms of benefit adopted or amended between April 17, 2002 and June 15, 2004 may still be applied to distributions before the end of 2005.
   3. Post-June 14, 2004 Amendments – Any amendments made on or after June 15, 2004 must comply with the final regulation. Moreover, if amendments are made to grandfathered benefit forms, such amendments will cause loss of the delayed effective date described in (1).

The Treasury and the IRS have advised the Department that the requirements of [the mandatory rollover rule] apply to a broad range of retirement plans including plans established under Code sections 401(a), 401(k), 403(a), 403(b) and 457.

Based on this language, the rules would apply to governmental Code section 401(a) plans, Code section 403(a) plans, Code section 403(b) plans, and Code Sec. 457(b) plans. (Prop Labor Reg 2550.404a-2 , fn. 7.)

1. The DOL safe harbor rule is only intended to protect plan fiduciaries from ERISA fiduciary liability for selecting an IRA provider and an initial IRA investment vehicle in connection with the mandatory rollover rule.
2. However, the DOL rule may also be instructive to governmental plans in satisfying their own fiduciary obligations under state or other applicable laws.
3. Moreover, these rules may also be important because IRA providers may be hesitant to allow regular IRAs to be used for small cashouts even if the plan certifies that it is not subject to ERISA.

1. Amount. The cashout amount is more than $1,000 but not more than $5,000, excluding prior rollover contributions if the plan’s involuntary cashout provision so provides.
2. Type of Account. The mandatory cashout must be directed to a traditional IRA (i.e., an individual retirement account under Code Sec. 408(a) or an individual retirement annuity under Code Sec. 408(b) ).
3. Type of Investment. The proposed regulation would limit investments to investment products designed to preserve principal and provide a reasonable rate of return, whether or not this return is guaranteed, consistent with liquidity and taking into account the extent to which charges can be assessed against the account. DOL indicated that permissible investment products would include money market funds, interest-bearing savings accounts, certificates of deposits, and “stable value products” (including guaranteed investment contracts and similar investments). DOL expressly rejected the idea that the safe harbor should permit “mapping” the distribution into investment products identical or similar to those in which the participant had directed his or her investments prior to the mandatory rollover.
4. Permissible Fees and Expenses. The fees and expenses relating to the IRA may include set-up charges, maintenance fees, investment expenses, termination costs and surrender charges—subject to two limitations.
   1. The fees and expenses relating to the “cashout” IRA may not exceed the fees and expenses charged by the provider for comparable IRAs established for voluntary rollover distributions.
   2. The fees and expenses (except for the set-up charges) may be charged to the IRA only to the extent of the income earned by the IRA. In other words, fees may not be charged against the IRA’s principal.
5. Disclosure. Before the mandatory cashout, participants must be furnished with a summary plan description (“SPD”) or a summary of material modifications (“SMM”) that includes an explanation of the mandatory cashout process. Because governmental plans are not required to have SPDs or SMMs, it appears they would be exempt from this requirement.
6. No Prohibited Transaction. The fiduciary’s selection of an IRA must not result in a non-exempt prohibited transaction.

1. Plan Amendment: Section 401(a) plans (and presumably all non-ERISA plans) must be amended to include the mandatory rollover rule if the plan otherwise includes an involuntary cashout provision. Will IRS issue model/sample plan language that will meet this requirement?
2. Can a plan amendment that simply cross-references the Code provision that includes the mandatory rollover rule be sufficient?
3. Plans should avoid incorporating the DOL regulations in the plan document (to avoid potential operational issues for failure to comply).
4. Timing of Plan Amendment: For 401(a) and 403(a) plans, a plan amendment generally must be made within the plan’s remedial amendment period, which for this amendment is the later of (1) the last day of the plan year when the law is effective, or (2) the due date (plus extensions) for filing the income tax return for the employer’s tax year that includes the effective date of the law. In no event will the deadline be earlier than EGTRRA’s remedial amendment period—currently the end of the 2005 plan year. However, the timing rules for 403(b) and 457 plans are less clear.
5. IRS Disclosure Rules:
   1. The Code (and legislative history) requires that the plan administrator (or payor for a 403(b) plan) revise the 402(f) notices (i.e., the statement that explains the right to roll over the distribution and the related tax consequences) to explain that an automatic direct rollover will be made for cashouts over $1,000 but not more than $5,000, unless the participant elects otherwise. ( Code Sec. 402(f)(1) ) The current IRS model notice ( Notice 2002-3 ) does not include this language. The plan administrator is also required to notify the participant in writing, as part of the 402(f) notice or separately, that the distribution may be transferred to another IRA. ( Code Sec. 401(a)(31)(B)(i) ) These disclosures will need to be provided for distributions made after the DOL safe harbor rule is “prescribed.”
   2. For 403(b) plans, is it the “payor” who is responsible for the disclosures?
   3. What is the timing of the IRS disclosure rules if it is not contained in the 402(f) notice? We assume that it would be the same as the 402(f) notice—which is generally 30-90 days before the distribution or the annuity starting date. What happens if there is a delay as a result of looking for missing participants?
   4. Will a summary 402(f) notice have to be revised for these new disclosure requirements?
   5. Presumably, the electronic delivery of the separate notice (if elected) would be permissible, in accordance with the current 402(f) electronic delivery provisions. Is there transition relief for distributions in process when the final regulations become effective; otherwise, all cashouts pending as of the effective date may need to be given new disclosures and election timelines. A revised model 402(f) notice to reflect these new rules would be helpful.
6. Minimum Required Distributions (“MRD”): Are minimum required distributions (e.g., age 70-1/2 payments) to a participant subject to the mandatory rollover rule? Presumably they are not, pursuant to the exception under the involuntary cashout provision for MRD payments. ( Reg. § 1.411(a)-11(c))(7))
7. Timing of Default Rollover: Is there a prescribed time frame within which the default rollover must be made? Current law does not prescribe a time frame for direct rollovers generally.
8. Use of Deemed IRAs: Can a plan sponsor use a deemed IRA as the designated default IRA, assuming they do not otherwise violate the Code’s prohibited transaction rules (Code Sec. 503 ) that apply to governmental plans.
9. Under $1,000: Can plans apply the mandatory rollover rule to cashouts of less than $1,000, or to accounts that fall below $1,000 due to processing delays? Presumably the answer would be yes, although the DOL safe harbor (see Part II above) may not apply.
10. Establishment of IRA: We anticipate that IRS will modify the Form 5305 series (model IRA documents) to permit a plan administrator to establish an IRA on behalf of a participant in a manner similar to the use of a designated financial institution for SIMPLE IRAs. Another option would be to allow prototype IRAs to accept the mandatory rollover, though this may require filing for a new opinion letter for the IRA.
11. Determination Letter Procedure: The determination letter process is not yet open for EGTRRA changes; therefore, 401(a) plans should not submit this amendment to IRS. However, a 403(b) or 457 plan may request a private letter ruling to confirm the mandatory rollover amendment. If IRS issues a sample/model plan amendment and it is timely adopted, it is unlikely that any further action would be necessary for continued reliance on the plan’s determination letter, advisory letter, or ruling.
12. Effective Date: What is the effective date for the mandatory rollover rule? Congress tied the effective date of the mandatory rollover rule to the DOL’s prescription of final regulations. How does this apply to plans subject to IRS but not DOL regulations?
13. Cashout of Beneficiaries and Alternate Payees: Does the mandatory rollover rule apply to involuntary cashouts of beneficiaries and alternate payees? Presumably, the rule would apply only to participants and alternate payees (but not to beneficiaries) with account balances or accrued benefits of $5,000 or less, pursuant to the exception under the involuntary cashout provision for payments after death. (Reg. § 1.411(a)-11(c)(5) and (c)(6).) However, the Code’s references in the mandatory rollover rule to both “participant” and distributee,” and the reference to “eligible rollover distribution” in the legislative history, make this unclear. For example, what happens if a participant dies but the plan sponsor is unaware of the death and rolls the money over to an IRA pursuant to the mandatory rollover rule? Can a surviving spouse beneficiary then treat the IRA as his or her own?

1. contributions to the plan cease with respect to payroll periods that begin after December 31, 2004, and
2. either of the following corrective actions is completed by December 31, 2005
   1. The eligible employer as defined under § 457(e)(1)(A) adopts the plan,
   2. The accounts of the employees under the plan are transferred (not rolled over) into an eligible governmental plan maintained by the eligible employer as defined under § 457(e)(1)(A) in accordance with the requirements of § 1.457-10(b)(4) of the Income Tax Regulations.