5500 Preparer's Manual for 2012 Plan Years
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Defined contribution plans with assets invested in employer securities must permit applicable individuals to divest their investments in employer securities in a manner that does not impose restrictions on these rights which differ from restrictions on the investment of other types of plan assets, according to new guidance issued by the IRS. In addition, plans may not offer benefits conditioned on investment in employer securities.
Under Code Sec. 401(a)(35), added by the Pension Protection Act of 2006 (PPA; P.L. 109-280), defined contribution (DC) plans, other than certain employee stock ownership plans (ESOPs), must provide applicable individuals with the right to divest publicly-traded employer securities held in their accounts and reinvest those amounts in certain diversified investments. With exceptions for certain collectively-bargained plans, the provision generally applies to plan years beginning after December 31, 2006. Until regulations under Code Sec. 401(a)(35) can be produced, the IRS has issued Notice 2006-107 to provide transitional guidance under this Code section.
The divestiture rights under Code Sec. 401(a)(35)(B) apply to elective deferrals and employee contributions, including after-tax and rollover contributions, and earnings thereon. The rights under Code Sec. 401(a)(35)(C) apply to other employer contributions, and earnings thereon. Participants are generally required to have completed at least three years of service in order to be considered "applicable individuals" with diversification rights under Code Sec. 401(a)(35). Applicable individuals must be permitted to divest the employer securities held in their accounts and to reinvest an equivalent amount in other investment options offered by the plan. (For employer securities acquired in a plan year beginning before January 1, 2007, the employee's right to divest employer securities is phased in over a three-year period.) The investment alternatives for those who divest employer securities must be of at least three different types, each with materially different risk and return characteristics.
It is permissible for the plan to limit the time for divestment of employer securities and reinvestment to periodic opportunities occurring at least quarterly, Notice 2006-107 states. However, it is not permissible for a plan to impose restrictions on these rights that differ from restrictions on the divestment of other types of plan assets, or to offer benefits conditioned on investment in employer securities. For example, a plan cannot give applicable individuals the opportunity to divest other types of investments more frequently than employer securities, nor can it give those who divest employer securities a lower rate of matching employer contributions than those who choose not to divest themselves of employer securities. It is permissible for a plan to, for example, restrict the percentage of a participant's account balance which can be invested in employer securities, as long as the limitations apply without regard to a prior exercise of rights to divest employer securities, Notice 2006-107 states. It is not permissible, however, to restrict a participant for a period of time from reinvesting in employer securities after divestment, because this limitation takes into account a prior exercise of rights to divest employer securities.
The PPA also added ERISA §101(m), which, for plan years beginning after December 31, 2006, requires plans to notify applicable individuals of their diversification rights under Code Sec. 401(a)(35) not later than 30 days before the first date on which the individuals become eligible for such rights. Notice 2006-107 includes a Model Notice providing sample language to be used in providing the required notice of divestiture rights to applicable individuals, as well as notice of the importance of diversification in retirement assets.
Comments on the transitional guidance contained in Notice 2006-107, and on the topics that need to be addressed in the regulations, should be submitted by March 18, 2007 to CC:PA:LPD:DRU (Notice 2006107), Room 5203, Internal Revenue Service, POB 7604 Ben Franklin Station, Washington, DC 20044 or electronically at: firstname.lastname@example.org.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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