As we previously reported, the Pension Protection Act of 2006 (the "Act") made significant changes to the laws governing retirement plans. While the effective dates of many of these changes are staggered over the next several years, there are two related changes that are effective almost immediately, for plan years beginning on or after January 1, 2007:
- a new plan qualification requirement whereby certain retirement plans that provide for investment in employer securities must permit participants to diversify out of such an investment.
- the sponsor of such a plan must provide participants with a notice of their right to diversify and describe the importance of investment diversification.
The notice must be provided 30 days prior to the first date on which the participants are able to exercise their diversification rights. On November 30, 2006, the IRS issued guidance delaying the time for providing this notice for plans subject to this new qualification requirement on or after January 1, 2007, but before February 1, 2007. Those plans are not required to furnish the notice earlier than January 1, 2007.In order to assist our clients in determining whether the new qualification requirement applies to their plan(s), this Alert contains additional details about the requirement. The Alert also describes the notice requirement and includes the model notice issued by the IRS. Plans subject to diversification requirement The diversification requirement applies to defined contribution plans holding publicly-traded employer securities (i.e., securities issued by the employer or a member of the employer’s controlled group of corporations that are readily tradable on an established securities market). The requirement does not apply to certain employee stock ownership plans or to plans covering one individual or only partners. Contributions affected by diversification requirement A participant must be allowed to immediately diversify both the pre-tax and after-tax employee contribution portion of his account balance invested in employer securities. With respect to the portion of a participant’s account balance attributable to nonelective employer contributions and/or employer matching contributions that is invested in employer securities, the right to diversify applies only to a participant with at least three years of service (based on the vesting rules) or the beneficiary or alternate payee of such a participant. A three-year transition rule applies to such employer contributions that are invested in employer securities acquired before the first plan year to which the diversification requirement applies.1 Under the transition rule, 33% of the previously-acquired employer securities are subject to diversification in the first plan year to which the diversification requirement applies, 66% of the previously-acquired employer securities are subject to diversification in the second plan year, and 100% of the previously-acquired employer securities are subject to diversification in the third plan year. Other investment alternatives The diversification requirement mandates that persons who have a right to diversify out of employer securities must have a choice of at least three investment options, other than employer securities, each of which is diversified and has materially different risk and return characteristics. A plan does not violate the diversification requirement by limiting the times permitted for divestment and reinvestment to periodic, reasonable opportunities occurring at least quarterly; participants generally must be given the opportunity to request changes with respect to investment in employer securities with the same frequency as the opportunity to make other investment changes, and such changes must be implemented in the same timeframe as other investment changes. A plan generally may not impose restrictions or conditions on the investment in (or divestment of) employer securities that are not imposed on the investment of other plan assets. Notice requirement Plans providing for investment in employer securities must provide a notice to each person who has the right to diversify out of employer securities no later than 30 days before such right is first exercisable. The notice must explain the diversification right and describe the importance of investment diversification.
Although some have suggested that separate notices are required if participants first become eligible to divest an account of employer securities attributable to elective deferrals at a different time than they first become eligible to divest an account of employer securities attributable to employer contributions, our reading of the Act suggests otherwise. The Act requires that the notice must be provided not later than 30 days before the first date on which a participant is eligible to divest employer securities with respect to "any type" of contribution. This can be interpreted to mean that a single notice is sufficient so long as it is provided at least 30 days before a participant first has any right to divest an account of employer securities. For example, if a plan provides for immediate diversification of employer securities attributable to salary deferral contributions and diversification of matching contributions only as vested, a single notice given at least 30 days prior to the date when a participant is first able to diversify any employer securities would appear to satisfy all further notice requirements. The required notice must be written in a manner calculated to be understood by the average plan participant and may be delivered in written, electronic or other appropriate form to the extent such form is reasonably accessible to the participant. Failure to provide the required notice can result in the imposition of a civil penalty of $100 per day, per participant. IRS model notice The model notice may have to be adapted to accurately reflect the provisions of your plan. The IRS points out that changes would generally be necessary if, for instance, the plan invests in more than one class of employer securities or it provides the same diversification rights for participants without regard to whether they have three years of service. Footnotes
1. The transition rule does not apply to plan participants who have three years of service and who have attained age 55 by the beginning of the first plan year beginning after December 31, 2005. Such participants can diversify immediately.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.