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5500 Preparer's Manual for 2012 Plan Years

5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.


IRS proposes diversification rules for defined contribution plans using employer securities

The IRS has issued proposed regulations under Code Sec. 401(a)(35) relating to diversification requirements for defined contribution plans that use publicly traded employer securities. The regulations are proposed to be effective for plan years beginning on or after January 1, 2009, although plans can rely on the proposed regulations before final regulations go into effect. IRS Notice 2006107 (see CCH Pension Plan Guide 17,135E), which provided initial guidance implementing the diversification rules, will also continue to apply until the regulations go into effect.

Divestment rights

The Pension Protection Act of 2006 (PPA; P.L. 109-280) added Code Sec. 401(a)(35) which provides participants and beneficiaries in defined contribution plans the right to divest employer securities in their accounts and reinvest in other diversified investments. Notice 2006107 provided guidance on such issues as permissible restrictions on a participant’s divestment and reinvestment election rights, the application of the rules to ESOPs, and whether investments in pooled investment vehicles were subject to diversification as plan holdings. The proposed regulations generally follow and expand the guidance in Notice 2006-107.

Code Sec. 401(a)(35)(A) provides that a trust that is part of a defined contribution plan is not a qualified trust unless it satisfies the diversification requirements of Code Sec. 401(a)(35)(B), (C), and (D) . Code Sec. 401(a)(35)(B) requires that each individual have the right to direct the plan to divest employer securities allocated to the individual’s account that are attributable to employee contributions and to reinvest in other investment options. Note: Employee contributions, for purposes of the diversification rules, include rollover contributions made under the plan.


Code Sec. 401(a)(35)(E)(ii) provides that an Employee Stock Ownership Plan (ESOP) that is a separate plan holding no contributions that are subject to Code Sec. 401(k) or 401(m) is not an applicable defined contribution plan subject to the diversification rules. The proposed regulations would clarify that a plan does not lose this exemption merely because it receives rollover contributions of amounts from another plan that are held in a separate account, even if those amounts were attributable to contributions that were subject to Code Sec. 401(k) or 401(m) in the other plan. In addition, the proposed regulations would reflect the exemption for one-participant retirement plans under Code Sec. 401(a) (35)(E)(iv).

Pooled investment vehicles

Notice 2006-107 provides that employer securities held by an investment company registered under the Investment Company Act of 1940 or similar pooled investment vehicle are not treated as being held by the plan and, thus, are not subject to diversification. The proposed regulations clarify the types of pooled investment vehicles that are exempt from the diversification requirements.

Under the proposed regulations, in order to be exempt from the diversification requirements, the pooled investment vehicle must be a common or collective trust fund or pooled investment fund maintained by a bank or trust company supervised by a state or federal agency, a pooled investment fund of an insurance company that is qualified to do business in a state, or an investment fund designated by the IRS.

Under Notice 2006-107, the holdings of the investment company or similar investment vehicle must be diversified so as to minimize the risk of large losses. The proposed regulations include the requirement that in order to be exempt from the diversification requirements the pooled investment fund that holds the employer securities must have stated investment objectives and the investment must be independent of the employer and its affiliates. The proposed regulations would add a percentage limitation rule to ensure that the investment in the employer securities through a pooled fund is not an attempt to evade the rules of Code Sec. 401(a) (35). Under this rule, if the employer securities held by the fund are more than 10 percent of the total value of all of the fund’s investments, then the fund is not considered to be independent of the employer.

Restrictions on diversification rights

Notice 2006-107 includes a rule that permits a plan to restrict the otherwise applicable diversification rights under Code Sec. 401(a)(35) for a period of up to 90 days following an initial public offering of the employer’s stock. Under the proposed regulations, this rule is extended to apply to the first 90 days after the plan becomes an applicable defined contribution plan. This situation could occur, for example, when some other entity in the controlled group first issues stock that is publicly traded or when a standalone ESOP first provides for contributions that are subject to Code Sec. 401(k) or 401(m).

Restrictions on employer securities

Notice 2006-107 permits a plan to impose a restriction on an investment in employer securities that is not imposed on a stable value fund. The proposed regulations extend this rule to a fund that is similar to a stable value fund. Specifically, in the case of a plan that has several investment funds, including a fund invested in employer securities, a fund which is a stable value or similar fund, and other funds which are not invested in employer securities, the plan will not be treated as imposing a restriction prohibited under Code Sec. 401(a)(35)(D)(ii)(II) merely because the plan permits transfers to be made into the stable value or similar fund more frequently than into the fund invested in employer securities.

Indirect restrictions or benefits

While the proposed regulations would generally prohibit indirect restrictions on an individual’s exercise of diversification rights, the rules would permit certain indirect restrictions, as well as certain indirect benefits that are conditioned on investment in employer securities. Under the proposed regulations, a plan would be permitted to limit the extent to which an individual’s account balance can be invested in employer securities. In addition, an applicable defined contribution plan would not violate a prohibition against reinvestment in employer securities by terminating any further investment in employer securities.

The proposed regulations would provide that a plan is not providing an indirect benefit that is conditioned on investment in employer securities merely because the plan imposes fees on other investment options that are not imposed on the investment in employer securities. In addition, a plan would not impose a restriction on the right to divest an investment in employer securities merely because the plan imposes a reasonable fee for the divestment of employer securities.

Restrictions on elections

Under Code Sec. 401(a)(35)(D) , a plan may limit the time for divestment and reinvestment of employer securities to periodic and reasonable opportunities, occurring no less frequently than quarterly. The proposed regulations would permit a plan to impose reasonable restrictions on the timing and number of investment elections that an individual can make to invest in employer securities, provided that the restrictions are designed to limit short-term trading in the employer securities. For example, a fund could limit the purchase of employer securities if there has been a sale within a short period of time, such as 7 days. The regulations, however, would not permit a plan to limit an individual’s right to divest employer securities.

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