Understanding the Automatic Rollover IRA

What is an Automatic Rollover?

ANSWER: An “automatic rollover“ is generally synonymous with a Safe Harbor IRA, which is a specialized individual retirement account (IRA), established when a qualified retirement savings plan elects to “force out” their small-balance (< $7,000, effective 12/31/23) participants, after they’ve separated employment. Automatic rollover IRAs are established for participants with vested account balances under $7,000 when they separate from their employer. These IRAs can be funded with proceeds from a previous employer's retirement plan, such as a 401(k).

• The terms “automatic rollover” and “safe harbor IRA” can be different in the sense that “automatic rollover” may refer more to the force-out process, whereas the Safe Harbor IRA is the end-state, financial instrument that houses the forced-out participant. As of December 31, 2023, automatic rollovers typically occur for account balances between $1,000 and $7,000. Balances under $1,000 may be cashed out by employers, triggering taxes and penalties for the employee, but can also be included in the automatic rollover process.
• Automatic rollover IRAs can be funded with proceeds from a previous employer's retirement plan, such as a 401(k). This process allows individuals to roll their retirement savings from a former employer into an IRA, preserving tax advantages and staying invested in their retirement.
• The process involves rolling over funds from a 401(k) or other employer-sponsored plan, and the former employer or previous employer initiates the automatic rollover when the participant separates from service.
• Not all plans have provisions to automatically rollover ex-employees with less than $7,000.
• Plans that elect to periodically automatically rollover these participants often see a benefit in “cleaning up” their plan from a build-up of small-balance accounts. A proliferation of small balance accounts can cause administrative burdens (ex. – lost & missing participants, uncashed distribution checks, etc.) and increased plan costs.

History of the Automatic Rollover

• In 2001, the 107th Congress of the United States passed EGTRRA, otherwise known as the Economic Growth Tax Relief Reconciliation Act. EGTRRA set forth rules dictating that employer-sponsored, qualified plans could make automatic distributions to terminated employees without their consent for small balances (less than $5,000), provided that balances between $1,000 and $5,000 be automatically rolled over to a Safe Harbor IRA.
• In 2004, the Department of Labor (DOL) issued final rules describing the automatic rollover safe harbor for plan fiduciaries tasked with choosing automatic rollover providers, as well as the initial Safe Harbor IRA investments. The DOL's rules applied to distributions made on or after March 28, 2005.
• In 2022, Section 304 of the SECURE 2.0 Act increased the mandatory distribution limit from $5,000 to $7,000, effective for distributions made after 12/31/23.

How Does the Automatic Rollover Process Work?

• Plans that have adopted “automatic rollover” provisions will typically select a services provider – which can be their current recordkeeper or a third-party automatic rollover provider (ex. – Retirement Clearinghouse).
• Periodically, plans will determine the participants who are automatic rollover-eligible – specifically, those former employees who have balances less than $7,000. On behalf of the plan, the plan’s recordkeeper or automatic rollover services provider will notify the eligible participants about the pending automatic rollover, providing them with the required disclosures, and giving them instructions and adequate time to take control of their situation prior to the automatic rollover. During this period, investors are given the opportunity to decide what to do with their money, including exploring other options such as transferring to another IRA, moving to a current 401(k), or choosing to withdraw funds. This period of time is typically 30 to 60 days.
• If the participant takes no action, their retirement savings are automatically rolled over to a Safe Harbor IRA. At this point, the former plan sponsor’s fiduciary responsibility to their former participant is concluded, and the former participant is now a Safe Harbor IRA accountholder.
• Once in the new Safe Harbor IRA, the former participant’s savings are automatically invested in a default investment vehicle, designed to protect principal. The new Safe Harbor IRA accountholder is typically mailed a Welcome Kit and is invited to take charge of their retirement savings in any manner they see fit.

Special Circumstances for an Automatic Rollover

• When a qualified defined contribution plan is being terminated, all unresponsive participants – regardless of balance – can be automatically rolled over and forced into a Safe Harbor IRA.

Plan Sponsors and Automatic Rollovers

Plan sponsors are at the heart of the automatic rollover process, acting as stewards of former employees’ retirement plan assets when employment ends. When a participant leaves a company and their retirement savings fall below the established threshold – currently $7,000 – plan sponsors may initiate an automatic rollover, transferring those funds into a Safe Harbor IRA. This approach not only preserves the tax-advantaged status of retirement savings but also helps prevent the possible loss of funds that can occur with a cash distribution.

Understanding the regulatory landscape is essential for plan sponsors. The Tax Relief Reconciliation Act and Department of Labor guidelines, enforced by federal government agencies, set the rules for how and when automatic rollovers can occur. Compliance with these rules ensures that retirement plan assets are handled properly and that both the plan and its participants are protected from unintended tax consequences.

Managing small balance accounts can be administratively burdensome and costly for retirement plans. Automatic rollovers offer a practical solution, allowing plan sponsors to reduce administrative costs and streamline plan management. By partnering with a reputable financial institution, plan sponsors can facilitate the rollover process efficiently, ensuring that former employees’ retirement accounts are transferred to a secure environment.

Selecting the right provider is a critical decision. Plan sponsors should evaluate potential partners based on the range of investment options offered – such as mutual funds and other diversified choices – the transparency of fees, and the quality of service provided to former employees. A strong provider will offer clear account information, competitive annual fees, and access to FDIC-insured or principal-protected investment options, helping former employees make informed decisions about their new account.

Effective communication is another key responsibility. Plan sponsors should ensure that former employees receive timely and comprehensive information about the rollover process, including details about their IRA accounts, the differences between traditional and Roth IRAs, and any tax information relevant to their specific situation. Providing resources and guidance empowers former employees to take control of their retirement savings, whether they choose to keep their funds in the new Safe Harbor IRA, transfer them to another eligible plan, or explore other investment options.

For plan sponsors, facilitating automatic rollovers not only benefits former employees but can also result in significant cost savings. By reducing the number of small balance accounts, sponsors can lower administrative costs and minimize the annual fees associated with maintaining inactive accounts. This creates a more efficient retirement plan for all participants.

Ultimately, plan sponsors play a pivotal role in ensuring that retirement plan assets are transferred safely and securely, while providing former employees with the tools and information they need to manage their retirement savings effectively. By working with a trusted provider and maintaining open communication, plan sponsors can help former employees avoid unnecessary taxes, preserve their retirement savings, and make the most of their investment opportunities.

More Information on Automatic Rollovers

Automatic Rollovers

Related Terms

Safe Harbor IRA

Auto Rollover

Auto Rollover Program

Auto Rollover IRA

Automatic IRA Rollover

Retirement Clearinghouse's Automatic Rollover Services

We believe that RCH automatic rollover service is clearly the best automatic rollover service in the market today. RCH is the only provider proven to reduce cash outs, to offer former participants with a beneficial monthly fee structure, and with a proven track record of consolidating former participants' retirement savings into an active retirement plan or existing IRA.

When considering an automatic rollover service provider, we encourage plan sponsors to consider the following criteria:

• Cashout rates: The percentage of automatic rollover-eligible participants that cash out their retirement savings completely, prior to moving to a Safe Harbor IRA. RCH is the only provider proven to reduce cashouts rates by over 50%, vs. industry averages for automatic rollover balances (26% v. 55%).
• Commitment to account consolidation: RCH has a demonstrated commitment, ability and track record in consolidating retirement savings balances. Most automatic rollover service providers prefer that Safe Harbor IRAs stay on their books as long as possible, incurring ongoing fees and offering the provider with an asset management opportunity. RCH takes the opposite approach. We believe it's best to move retirement savings forward to an active plan or to an existing IRA.
• A unique monthly fee structure: Because RCH actively seeks to consolidate Safe Harbor IRA assets with the account holders' existing retirement accounts, RCH charges only for the time the account is open – a monthly fee – rather than an annual fee paid in advance. Using a monthly fee structure is highly advantageous for short-term accountholders who are automatically rolled over to a Safe Harbor IRA.
• Progressive distribution fee structure: RCH employs an algorithm that lowers the distribution fee as the Safe Harbor IRA account falls below a threshold.
• Investment Choice: RCH offers over 40 different investment options in five different fund families from which to choose, should an accountholder wish to move their savings out of the default Safe Harbor IRA fund – with no transaction fees or lock up provisions on any investment options.
• Customer Service: The RCH Service Center is available to accountholders Monday – Friday, 8 a.m. to 7 p.m. Eastern Time, with bi-lingual support including multiple, full-time native Spanish-speaking representatives. RCH also provides a fully functional web portal for customer access, account maintenance and self-service.
• Independence: RCH is independent, transparent and un-conflicted, with no hidden fees paid to third parties, and no lock-up provisions in our default investment funds.

Taken together, these attributes clearly establish the RCH automatic rollover service as the most fiduciary-friendly automatic rollover service in the industry.