Employee Plans News - Summer Edition - Final Regulations on Investment Diversification Requirements
On May 18, 2010, the IRS and the Treasury Department released final regulations on Code §401(a)(35) investment diversification requirements for certain defined contribution plans with publicly traded employer securities.
DC plans holding publicly traded employer securities are considered "applicable defined contribution plans” and subject to the diversification requirements of Code §401(a)(35). These plans must contain at least three investment options other than employer securities. The diversification requirement applies to:
- employee contributions; and
- employer contributions allocated to participants (or their beneficiaries) with at least three years of service.
A plan can’t restrict a participant’s right to invest in or to divest employer securities any more than it restricts any other plan investment options. However, the final regulations modify some of the permitted restrictions:
- A plan may have more frequent transfers to and from stable value funds and qualified default investment alternatives than a fund invested in employer securities.
- A plan may not allow reinvestment of divested amounts in the same employer securities account, but may allow investment of those amounts in another employer securities account if the only difference between the two accounts is the Code §402(e)(4) cost or other basis.
- Under a transitional rule, certain leveraged ESOPs may allocate matching contributions to an otherwise frozen employer stock fund.
Exceptions to the diversification requirements include a:
- stand-alone ESOP that does not hold amounts attributable to §§401(k) or (m);
- one-participant retirement plan; or
- plan with an investment fund holding employer securities as part of a broader fund is not treated as holding employer securities if the:
- investment was independent of the employer;
- employer’s securities did not exceed 10% of the fund; and
- employer securities were held indirectly through:
- an investment company registered under the Investment Company Act of 1940;
- 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 qualified insurance company’s pooled investment fund; or
- any other IRS-designated investment fund.
The final regulations:
- do not treat a multiemployer plan as holding employer securities if they are held indirectly through an investment fund managed by an independent investment manager and do not exceed 10% of the fund;
- extend the types of allowed investment companies to include certain exchange traded funds;
- state that in determining whether the value of employer securities exceeds 10% of the fund's investment’s total value for a plan year, use the value at the end of the preceding plan year; and
- provide that if a fund that indirectly holds employer securities doesn’t meet the “independent of the employer” requirement, it meets the diversification requirements even if the plan doesn’t offer diversification rights to the participants for up to 90 days after it is found to hold employer securities.
The final regulations are effective May 19, 2010, and apply for plan years beginning on or after January 1, 2011. Until then, plans may satisfy Code §401(a)(35) by relying on Notice 2006-107, the proposed regulations or the final regulations.
