2007-05-21
The U.S. Department of Labor issued an interim final rule on distributions from terminated individual account plans.

On February 15, 2007, the Employee Benefits Security Administration of the U.S. Department of Labor (DOL) published an interim final rule that amends the regulation on distributions from terminated individual account plans under ERISA Section 404. The interim final rule modifies the safe harbor in the regulation to reflect a provision in the Pension Protection Act of 2006 (PPA) that permits distributions on behalf of nonspouse beneficiaries to be rolled over into individual retirement plans, with favorable tax treatment for the nonspouse beneficiaries.

Background

ERISA Reg. Section 2550.404a-3 provides for plan fiduciaries of terminated plans a fiduciary safe harbor (which, if satisfied, will be deemed to meet ERISA's 404(a) prudence requirements) for making distributions on behalf of participants or beneficiaries who fail to make an election as to the form of benefit distribution. This safe harbor required the distribution to be made to an account that was not an individual retirement plan because at the time the regulation was published (April 2006), a distribution from an individual account plan to a nonspouse beneficiary was not considered an eligible rollover distribution under Code section 402(c) and therefore could not be rolled over to an individual retirement plan. As a result, the distribution to the nonspouse beneficiary resulted in the payments being subject to income tax and mandatory withholding.

PPA changed the tax rules for distributions on behalf of nonspouse beneficiaries for distributions made after 2006. PPA amended Code section 402(c) to allow the direct rollover of a deceased participant's benefit from an eligible retirement plan to an individual retirement plan, established on behalf of a designated nonspouse beneficiary. The rolled-over distribution is not subject to mandatory tax withholding, and the nonspouse beneficiary is not subject to immediate income tax. The nonspouse beneficiary is treated as inheriting an individual retirement plan and may enjoy continued tax-deferral of the benefits, similar to that available to participants and spouses.

Interim Final Rule

In the interim final rule published on February 15, 2007, the DOL modified the safe harbor under ERISA Reg. Section 2550.404a-3(d)(1)(ii) to reflect the favorable tax treatment extended to nonspouse beneficiaries by PPA. The safe harbor now requires that in the case of a distribution on behalf of a missing, designated nonspouse beneficiary, the deceased participant's benefit be directly rolled over to an inherited individual retirement plan established to receive the distribution on behalf of the beneficiary.

The DOL also revised the model Notice of Plan Termination under ERISA Reg. Section 2550.404a-3 to specify that if a nonspouse beneficiary does not make a timely election, the account balance will be transferred directly to an inherited individual retirement plan.

The interim final rule requires qualified termination administrators of abandoned plans to make similar rollover distributions on behalf of missing nonspouse beneficiaries to qualify for the fiduciary safe harbor.

The interim final rule applies to distributions made on or after March 19, 2007.

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