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In this article we review the Department of Labor’s recently (January 29, 2024) proposed regulation implementing SECURE 2.0’s statutory prohibited transaction exemption for automatic portability transactions that meet certain conditions.
Automatic portability is, in effect, a “different way” to implement mandatory distributions (distributions of vested benefits of a terminating participant of $7,000 or less). Automatic portability uses – via an automatic portability provider (think “clearinghouse”) – a “money follows the participant” model. A collateral benefit of an automatic portability system is that, to some extent, it might solve problems with missing/unresponsive participants. And indeed, DOL’s proposal would (as discussed below) require the automatic portability provider to undertake routine participant searches.
We review DOL’s proposal in some detail (even though much of it repeats earlier guidance that was, in effect, codified by SECURE 2.0) as a resource for sponsors interested in this approach to mandatory distributions.
Background – Mandatory distributions
Under the Tax Code, a qualified retirement plan may distribute the benefit of a participant who is terminating employment, without the participant’s consent, if the participant’s vested accrued benefit is $7,000 or less ($5,000 or less for distributions prior to 2024). These are called “mandatory distributions.”
However, if the mandatory distribution is more than $1,000 and the participant hasn’t elected to take the distribution directly (or does not elect to transfer it to another plan), then the plan must distribute the benefit to a designated IRA. These are called ‘‘automatic rollovers.”
DOL provides a safe harbor for automatic rollovers under which the IRA designation and initial investment are deemed to satisfy ERISA fiduciary rules if certain requirements are met. Those rules include a requirement that assets are invested “in an investment product designed to preserve principal and provide a reasonable rate of return.” These are called “Safe Harbor IRAs.’’
Automatic portability
Automatic portability transactions are (as noted) “money follows the participant” transactions, in which, on distribution, the plan benefit is “parked” in an IRA and then, when the participant shows up in another employer’s plan, those assets in the IRA are transferred to an account in the participant’s new plan. IRS describes an automatic portability “framework” as follows:
An automatic portability transaction … is part of a larger framework for facilitating the movement of assets from one tax favored retirement plan to another. The overall terms and details of an automatic portability framework would generally be memorialized in contracts with recordkeepers, plan sponsors, and the automatic portability provider. A comprehensive automatic portability framework includes three key components. First, there is a ‘‘transfer out’’ plan that initiates a mandatory distribution. Second, there is an IRA … (a Default IRA) to receive (via a rollover) and hold the distributed funds. Third, there is a ‘‘transfer-in’’ plan that receives the roll in distribution from the Default IRA when an IRA owner is matched with an account in an eligible employer sponsored plan at a new employer.
Fiduciary/prohibited transaction issues
Generally, the selection and monitoring of an automatic portability provider will be (as it is with the retention of any service provider) a fiduciary act. The transfer by an automatic portability provider from the Default IRA to a new employer’s plan without the participant’s consent is a fiduciary act.
The receipt compensation/fees by the automatic portability provider (either from the participant or from a plan) in connection with automatic portability services (as the DOL puts it) “implicates the prohibited transaction provisions [of the Tax Code].” DOL has provided temporary prohibited transaction relief for these transactions, which was set to expire on July 31, 2024. SECURE 2.0 created a statutory exemption for them, subject to certain conditions, and DOL’s proposal implements and clarifies that statutory exemption.
Conditions
In order for an automatic portability provider to receive compensation/fees in connection with automatic portability transactions, DOL’s proposal (as noted, implementing a provision of SECURE 2.0) would provide a prohibited transaction exemption (PTE). That PTE is subject to the following conditions:
Acknowledge fiduciary status. The automatic portability provider must acknowledge fiduciary status in writing upon being engaged by a plan fiduciary and in certain required notices and disclosures.
Reasonable compensation standard. The automatic portability provider’s fees are subject to a “reasonable compensation” standard. In this regard, the automatic portability provider must disclose the compensation/fees it receives in the same manner/to the same extent that any other service provider would. The automatic portability provider is prohibited from receiving any compensation from third parties and from receiving fees in connection with a transaction involving a plan that it (or an affiliate) sponsors.
Restriction on use of data. The automatic portability provider may not use any of the data it receives “for any purpose other than to execute the automatic portability transactions or locate missing participants.”
Open participation. The automatic portability provider must “offer automatic portability transactions on the same terms to any transfer-in plan” and may not restrict any plan, IRA provider, or recordkeeper from working with other automatic portability providers.
Participant searches. Twice in the first year an automatic portability account is established and once a year after that, “the automatic portability provider must perform ongoing participant address validation searches via automated checks of (1) National Change of Address records, (2) two separate commercial locator databases, and (3) any internal databases maintained by the automatic portability provider.” And, “[i]f a valid address is not obtained from the automated checks, the automatic portability provider must also perform a manual internet-based search.”
Monitoring by a transfer-in plan official/fiduciary. A plan official (who generally will be a fiduciary, subject to ERISA prudence standards) must be designated to monitor “transfer-in” transactions and ensure that “amounts received on behalf of a participant are invested properly.” In the latter regard, “[a]mounts received are deemed to be invested properly if made in accordance with the participant’s current investment election under the plan or, if no election is made or permitted, in the plan’s qualified default investment alternative [QDIA] … or in another investment selected by a fiduciary with respect to such plan.”
Limited discretion. The proposal would place limits on the timing of automatic portability transactions and on the exercise of discretion by the automatic portability provider, generally under procedures that “set specific standards and timeframes.”
Independent audit. Under the proposal, the automatic portability provider would have to retain an independent auditor to do an annual compliance audit. The audit must be completed within 180 days of the end of the year and submitted to DOL within 30 days of completion. The automatic portability provider must certify the audit, including a certification that it has addressed any compliance issues identified in the audit.
Website. The automatic portability provider must maintain a website with information on fees, a list of recordkeepers it deals with, and the number of plans and participants it covers.
No exculpatory provisions. The automatic portability provider generally may not include any exculpatory provision in its contracts with plans.
Records retention for six years. The automatic portability provider generally must retain transaction records for at least six years.
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Comments on the proposal are due on March 29, 2024.
We will continue to follow this issue.