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The required amendment adoption date for many of the SECURE 2.0 Act of 2022 (SECURE 2.0) provisions is December 31, 2026. While plan sponsors may be focused on the significant mandatory changes imposed by SECURE 2.0, such as the mandatory Roth catch-up requirement, plan sponsors should not forget about the optional provisions which may offer meaningful benefits for their plans and participants. This article calls attention to SECURE 2.0's optional provision that allows plan sponsors to increase the automatic cash-out limit for former employees' vested account balances from $5,000 to $7,000 and summarizes key considerations for plan sponsors evaluating whether to adopt this increased threshold.
Background
Qualified retirement plans have long been permitted to distribute a terminated participant's vested account balance without the participant's consent if the balance does not exceed a statutory dollar limit. If a participant does not affirmatively elect a distribution or rollover of balances between $1,000 and the applicable limit, then the plan must automatically roll the funds into an individual retirement account (IRA) established on the participant's behalf. Prior to SECURE 2.0, the statutory dollar limit was set at $5,000. SECURE 2.0 raised the statutory ceiling to $7,000. Adoption of the higher limit, however, remains at the plan sponsor's discretion. Plan sponsors wanting to use the higher threshold must do so by adopting a formal plan amendment by December 31, 2026, and be sure that they are operating their plan in a manner consistent with the terms of that amendment from and after the designated effective date.
Practice Pointer: Some prototype plans have already rolled out their SECURE 2.0 amendment and used the earliest effective date permitted for certain changes (in the case of the increased cash-out rule, January 1, 2024). Sponsors using a prototype plan should be sure that their plans have been operated in compliance with the rule since the designated effective date and, if not, revise the effective date to be consistent with plan operation.
Benefits of Adopting the $7,000 Cash-Out Limit
Plan sponsors may find several benefits to implementing the increased cash-out threshold:
- Raising the limit reduces administrative burden for plan sponsors by allowing the plan to distribute a greater number of small accounts belonging to terminated participants. Maintaining accounts for participants who are no longer actively contributing generates ongoing administrative costs, including recordkeeping fees, required notices, and the effort associated with locating missing participants. By increasing the cash-out threshold, sponsors can more efficiently remove these accounts from the plan.
- A higher cash-out limit may improve overall plan health. Small, inactive participant accounts can negatively affect plan metrics and, in some cases, may increase per-participant fees assessed by recordkeepers who charge a fee based on the number of participants. Reducing the number of such accounts may lead to cost savings and more favorable plan statistics.
Plans with less than 100 participants with account balances at the beginning of the year are considered small plans for purposes of the Form 5500 filing and are exempt from the annual audit requirement for large plans. Removing small, inactive participant accounts from the plan may help a plan on the borderline of losing its small plan filer-status maintain such status and avoid the cost of having a plan audit performed by an independent accounting firm.
Drawbacks to Adopting the $7,000 Cash-Out Limit
Don't be fooled by the potential benefits, however. Plan sponsors should weigh countervailing factors before determining if the increased cash-out limit is right for their plan, including:
- Inactive participants with balances between $5,000 and $7,000 may prefer to keep their funds in their former employer's plan, particularly if the plan offers favorable investment options or lower fees than the alternative: an IRA established for the participant, as discussed above. Automatic distributions may disrupt participants' retirement savings strategies.
- Adopting the higher limit requires administrative tasks and coordination with recordkeepers and custodians which, if not done correctly, could result in operational errors. Before adopting the higher limit, keep in mind that this change requires a formal (and timely) plan amendment and corresponding updates to summary plan descriptions and participant communications. Plan sponsors should also confirm that their service providers are prepared to administer the increased limit before adoption.
- Plan fiduciaries should evaluate whether the current automatic rollover IRA provider designated under the plan will continue to be a prudent option, particularly given that a potentially larger pool of accounts may be subject to automatic rollover.
Conclusion
The decision to adopt the $7,000 automatic cash-out limit involves balancing administrative efficiency against participant impact and implementation costs. Plan sponsors should consult with legal counsel and their plan service providers to assess whether this optional change aligns with their plan's objectives and participant demographics.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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