5500 Preparer's Manual for 2012 Plan Years
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The IRS has extended, past 2007, transitional relief provided for grandfathered investments from the diversification requirements applicable to defined contribution plans (e.g., 401(k) plans) holding publicly traded employer securities.
CCH Note: The relief extends transition guidance that the IRS had issued in Notice 2006-107 (CCH Pension Plan Guide ¶17,135E). Plans would be required to continue to apply the prior guidance until the IRS issues regulations implementing the diversification rules under Code Sec. 401(a)(35) , which will not be effective before plan years beginning on or after 2009.
Under Code Sec. 401(a)(35), 401(k) plans must, as a condition of qualification, provide plan participants and beneficiaries with the right to divest publicly traded employer securities held in their individual accounts. Employers are required to provide advance notice to participants, informing them of their diversification rights within 30 days of their eligibility to exercise those rights.
Divestment rights apply to employee and employer matching contributions invested in employer securities. Plan participants (and beneficiaries with accounts under the plan with respect to which they may exercise the rights of participants and alternate payees) are empowered to direct the plan to immediately divest their individual accounts of employer securities in which their elective deferrals and after-tax employee contributions (including earnings thereon) have been invested, and direct the investment of an equivalent amount of assets among alternative investment options under the plan. Note, employee contributions for purposes of the diversification rules, include rollover contributions made under the plan.
Plan participants, alternate payees, and beneficiaries of deceased participants are also entitled to diversify holdings attributable to other employer contributions. Specifically, participants who have completed three years of service, alternate payees who have accounts under the plan with respect to a participant who has completed three years of service, and beneficiaries of deceased participants may divest individual accounts of employer securities that are attributable to matching and nonelective contributions.
Restrictions on divestment and reinvestment. A plan may limit the time for the divestment and reinvestment of employer securities to periodic and reasonable opportunities, occurring no less frequently than quarterly. However a plan may not impose restrictions or conditions with respect to the investment of employer securities that are not imposed on the investment of other plan assets (other than restrictions or conditions imposed under securities laws). Thus, a plan may not place restrictions on an individual’s right to divest an investment in employer securities that is not imposed on an investment that is not in employer securities. Nor may a benefit be conditioned on an investment in employer securities.
Restrictions on investment in employer securities. Restrictions on investments in employer securities may be implemented, as long as the limits apply without regard to a prior exercise of divestment rights. Thus, for example, a plan may limit investments in employer securities to 10 percent of an individual’s account balance.
In addition, a plan may include a provision under which an employer securities investment fund is closed. Under such a restriction, other amounts invested under the plan may not be transferred into an investment in a class of employer securities and no contributions may be invested in that class of employer securities.
Fees on alternative investment options. A plan is not prohibited from imposing fees on other investment options under the plan merely because fees are not imposed with respect to investments in employer securities.
Pursuant to transition relief issued by the IRS in Notice 2006-107, plans could continue to impose certain restrictions through 2007 under plan terms in effect on December 18, 2006. Thus, until January 1, 2008, a plan could apply a divestment restriction or condition that did not apply to a stable value fund. In addition, a plan could continue to restrict participants from divesting employer securities on a more than periodic basis, while allowing participants to divest other investments on a more frequent basis, as long as the other investment was not a generally available investment (e.g., the other investment is restricted to a fixed class of participants).
Under the initial relief, any restriction that continued to be imposed after 2007 would violate Code Sec. 401(a)(35)(ii)(II) . In the instant relief, the IRS has extended the transition relief provided for grandfathered investments for the period prior to January 1, 2008 to a period after 2007, but only until regulations that the IRS plans to issue under Code Sec. 401(a)(35) go into effect.
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