An automatic rollover IRA is established by an employer on behalf of a former employee who has left a small account balance in the employer’s retirement plan. If the retirement plan contains a “cashout” provision for account balances under $5,000, the employer must cash out the accounts of former employees who have not provided instructions on how to distribute their account. For cashouts over $1,000, employers must establish an automatic rollover IRA on behalf of the former employee and roll over the account balance to the IRA. Cashouts of $1,000 or less may be either rolled over to an IRA or paid to the former employee (typically by mailing a check), depending on the terms of the plan document.
An automatic rollover IRA is established either as a traditional IRA or a Roth IRA (depending on the type of assets in the employer’s plan) and receives all the same tax benefits as an IRA funded with annual contributions (e.g., tax-deferred investment growth). Individuals who have not made a distribution election but are being forced out of the plan will not have any immediate tax consequences and their savings are preserved for retirement. Employers are allowed to clear out small accounts that can cause compliance issues and increase plan costs. Automatic rollovers can also help reduce the staff burden and costs associated with keeping track of former employees in order to administer their accounts and deliver benefit statements and other notices.
Anyone who has left behind savings in a former employer’s 401(k) plan, 403(b) plan, or governmental 457(b) plan may have an automatic rollover IRA established on their behalf. Automatic rollovers typically occur when a worker leaves employment with the company and doesn’t provide updated contact information or does not respond to plan mailings or notifications. If an employer’s plan includes a cashout provision, the employer is required to make the automatic rollover on behalf of individuals who meet the criteria.
When determining if an individual’s account balance is under the $5,000 threshold to be eligible for a cashout and automatic rollover, employers may disregard any rollover dollars in the individual’s plan account. If the account is cashed out and rolled over, however, any rollover dollars in the plan account must be included in the automatic rollover to the IRA.
The employer must establish an agreement with the IRA custodian who will receive the automatic rollover assets and may sign documents to establish IRAs on behalf of their former employees. Automatic rollover IRA assets are generally invested to preserve principal and provide a reasonable rate of return (e.g., certificates of deposit, money market funds). Fees for these types of IRAs cannot exceed the fees charged for comparable IRAs held with the IRA custodian.
Employees participating in a retirement plan at work should receive a Summary Plan Description (SPD) from their employer when they enter the plan. You may also request one at any time. The SPD describes features of the plan, including the plan’s procedures regarding automatic rollovers. When an employee leaves the employer and has a balance in the retirement plan, the employer will provide a distribution notice that explains the plan’s distribution options and identifies the automatic rollover IRA custodian chosen by the employer. When an automatic rollover is pending, the retirement plan administrator may attempt to notify the individual again to provide instructions for accessing the IRA with the IRA custodian.
The IRA custodian accepting the rollover assets will also attempt to mail information about the IRA to the IRA owner’s last known address and may make additional attempts to find the IRA owner.
As the IRA account owner, you may assume full control of the account. When you contact the IRA custodian to assert ownership of your IRA, you will have to prove your identity. You should review the investment options and services offered by the IRA custodian to determine whether the provider is a good fit for your retirement savings goals.
If you are eligible to make annual contributions to a traditional or Roth IRA, you may make contributions to the automatic rollover IRA.
You can take distributions from your automatic rollover IRA at any time. The portion of the distribution that will be taxable to you depends on the type of assets rolled over. If you are not yet age 59½ when you take money out of your rollover IRA, you will be subject to a 10% early distribution tax on the taxable portion you withdraw.