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Threshold for Involuntary Cash-outs Increased

  • February 1, 2000

The Taxpayer Relief Act of 1997 allows a qualified plan to make a mandatory lump sum distribution upon a participant’s termination of employment, death, or other disqualifying event without participant or spousal consent, if the total benefit (account balance or present value) is less than $5,000. Previously, the dollar limit was $3,500.

A plan may apply the new $5,000 maximum at any time after the start of the first plan year following August 5, 1997. For a calendar year plan, this would be any time after January 1, 1998. The change is not automatic. Employers may adopt a policy to presently apply the new maximum (no immediate amendment is required) or wait until later to adopt the change. The new higher maximum can even be applied to participants who terminated before the change is made effective. Eventually plan amendments reflecting the actual implementation date will be required (see article below). Employers making the change must be careful to comply with other distribution election and notice requirements (e.g., for direct rollovers) and advise participants of any policy to force distributions if no election form is returned.

Any plan policy concerning non-consensual cash outs needs to be applied uniformly to all affected participants. Benefits that are currently being paid out in installments or as an annuity may not be cashed out without participant consent. Under the prior “look back rule”, if the value of the benefit exceeded the old maximum as of the time of any earlier distribution , it could not be cashed out without participant consent. The new rules eliminate the "look back rule" and now allow immediate cash-out without participant or spousal (if applicable) consent if the value of the benefit is currently less than $5,000.

The ability to cash out small benefit amounts should reduce a plan’s administrative expense without worrying about obtaining consent under the old "look back rule". For a defined benefit plan, this will reduce the plan’s PBGC premium obligation for future years. Defined benefit plan sponsors applying the new non-consensual cash-out limits may also consider replacing the plan's factors for computing lump sums (if tied to the PBGC rates) to typically more advantageous "GATT" factors (named after 1994 GATT legislation). This change requires a plan amendment, which can produce favorable results. GATT interest rates, based on 30 year treasuries, will generally result in smaller lump sums for younger employees than PBGC interest rates, which recently have ranged from 4% to 5%.

Editor's Note: This summary highlights the important issues that plan sponsors will need to address as they prepare for final document updates.

©2000 Jackson Lewis P.C. This material is provided for informational purposes only. It is not intended to constitute legal advice nor does it create a client-lawyer relationship between Jackson Lewis and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material. This material may be considered attorney advertising in some jurisdictions. Prior results do not guarantee a similar outcome.

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