Handling Cashout Distributions
By Cindy Fairchild, QKA, QKC, QPA, CIP
Can plan sponsors cash out the balance of a terminated participant’s account from their plan?
If elected in the plan document, a plan sponsor can cash out a terminated participant’s account if the balance in the account does not exceed the threshold identified in the plan document, following appropriate notification to the terminated participant.
What is the maximum amount that plan sponsors can elect for a cashout level?
Under Section 304 of the SECURE 2.0 Act, the maximum cashout level that can be elected by a plan sponsor for distributions made after December 31, 2023, is $7,000. Before this change, the maximum cashout threshold was $5,000.
How is the account balance determined?
When reviewing a terminated participant’s account balance to determine if the account is subject to the cashout provision, the plan document must be reviewed to determine
the plan’s cashout level,
whether rollovers will be included or excluded in the account balance, and
what is required to be distributed in cash vs. rolled over to an IRA.
Plan sponsors can elect to distribute balances of $1,000 or less in cash, or they can require all cashout distributions to be rolled over to an IRA. Account balances greater than $1,000 but not exceeding the cashout level must be directly rolled over to an IRA.
If the account balance is determined to not exceed the plan’s cashout level, the next step is to determine if the account contains both pretax and Roth assets. If the account contains only one asset type, the distribution method is determined based on the total account balance. If the account contains both asset types, each type will be evaluated separately to determine the distribution method, based on the rules elected in the plan document.
Example: The plan document has a $7,000 cashout level. Under its terms, balances of $1,000 or less will be distributed in cash and balances exceeding $1,000 must be directly rolled over to an IRA. The terminated participant’s total account balance is $4,500 with $3,700 in pretax assets and $800 in Roth assets. Because the total account balance does not exceed the cashout level, this account qualifies for the cashout provision and, if cashed out, the $3,700 in pretax assets will be directly rolled over to a Traditional IRA and $800 will be distributed in cash to the participant.
What type of notification should be given to participants?
Before directing the cashout of a terminated participant’s account, the plan sponsor must provide the terminated participant with information that details the plan’s cashout rules, the deadline for the participant to respond with distribution instructions (at least 30 days), the actions that will be taken if the participant fails to respond, instructions on how to request a distribution, and the 402(f) distribution notice. The participant can also be referred to the summary plan description, which provides information on the distributable events available, as well as the cashout rules that apply to the plan.
If a cashout provision is elected in the plan document, how often should accounts be reviewed?
Plan sponsors must establish administrative procedures that define the parameters on how they will operate the cashout provision (unless they have elected to not adopt a cashout provision). Typically, these procedures will incorporate the distribution rules defined in the plan document, such as the timing of when a terminated participant can request a distribution of her account as well as the frequency of when the plan sponsor will review terminated participant account balances eligible for the cashout process.
What is the benefit of having a cashout provision in a retirement plan?
Because many fees are based on the number of plan participants, the cashout provision allows plan sponsors to remove small balances from the plan, reducing the participant count, and thereby potentially reducing overall plan costs. Using a cashout provision also reduces the chances of terminated participants becoming lost or missing participants, which is not uncommon for those with small balances.
