Employers may provide IRA rollover as default option for small plan balances.

• Author: Lerman, Jerry L.

Current tax law allows a qualified retirement plan to involuntarily distribute a departing employee's retirement balance to the employee in cash if his vested balance is $5,000 or less. Alternatively, most plans allow an employee to choose to roll over the balance into another qualified plan or an individual retirement account (IRA). While most employees with small balances take the cash option, they tend to be more likely to roll the assets into another qualified plan or IRA as the balances increase.

In Rev. Rul. 2000-36, the IRS approved a company's plan to make an IRA rollover the default option for cashed-out benefits. In the ruling, a corporation maintained a defined contribution plan for its employees. The plan did not permit after-tax contributions or other additions that would not be included in gross income if distributed to the employee. The plan provided that an employee who separated from service with an account balance of $5,000 or less would receive an involuntary distribution of plan assets, but also included a direct rollover option for all distributions. However, as is the customary practice, an employee had to affirmatively elect a direct rollover to another qualified plan or IRA or the plan balance would be distributed in a single-sum cash payment.

The corporation amended its plan so that the default form of payment of any involuntary cash-out between $1,000 and $5,000 would be a direct rollover to an IRA. The default provision would apply only if the employee did not affirmatively request a cash payment or a rollover to another plan or IRA. If the employee failed to make an affirmative election, the corporation's plan administrator would select an unrelated IRA trustee, establish an IRA with the trustee on behalf of the departing employee and make initial investment choices for the account.

The corporation would amend the required Sec. 402(f) notice on eligible rollover distributions...