Cash-out distribution (involuntary cash-out)

What a cash-out distribution is

The plan document has to include a cash-out provision and state the limit, which can be anything up to $7,000. Before paying, the plan sends the former employee a notice explaining their options. If they do not respond, a balance of $1,000 or less can be paid by check. A balance above $1,000 has to be rolled into an IRA opened in their name.

Why it matters to employers

Cash-outs keep small accounts of former employees from building up. That lowers the participant count used for the plan audit threshold and reduces the number of people you may later be unable to find. The Department of Labor provides a safe harbor for choosing the automatic rollover IRA provider and its investment, which must be designed to preserve principal.

Example

A former employee leaves $4,200 in the plan and ignores the notices. After the notice period, the plan rolls $4,200 into an automatic rollover IRA in her name. Another former employee has $600 and receives a check for $480 after 20% federal withholding.

Common mistakes

• Using the $7,000 limit when the plan document still says $5,000. The document has to be amended first.

• Sending no notice before the payment.

• Applying the cash-out rule to people who still work for you.