New Diversification Requirements in the Pension Protection Act of 2006 Will Create Better Defined Contribution Plans

New Diversification Requirements in the Pension Protection Act of 2006 Will Create Better Defined Contribution Plans

As a result of the Pension Protection Act of 2006 (PPA), Section 401(a)(35) was added to the internal Revenue Code (Code), implementing diversification requirements for defined contribution plans holding publicly-traded employer securities. In accordance with the new rules, employers sponsoring qualified defined contribution plans are required to notify participants of their right to divest plan accounts invested in the publicly traded securities of the employer.

Individuals and Types of Contributions Affected

Under the new rules, individuals with plan accounts invested in employer securities must be provided with diversification rights. This includes participants, alternate payees and beneficiaries of a deceased participant with account balances comprising elective deferrals and employee contributions (and earnings thereon). Employee contributions include both after-tax and rollover contributions.

In addition, diversification rights must also apply to plan accounts that include employer contributions. Diversification rights are required to be available to participants who have completed three years of service, alternate payees who have been awarded an account from a participant with three years of service, and beneficiaries of a deceased participant.

When counting hours of service, a participant completes three years of service immediately after the third vesting computation period provided under the plan. For plans using the elapsed time method of crediting service, a participant has three years of service on the third anniversary of the participant’s date of hire.

The diversification rules do not apply to employee stock ownership plans (ESOP) if there are no elective deferral contributions, after-tax contributions or matching contributions held in the ESOP.

The Diversification Requirements

Under the diversification rules, a plan must offer not less than three investment options (in addition to the employer securities) that individuals may choose from and each investment option must be diversified and offer materially different risk and return characteristics. Those plans that conform to Section 404(c) of the Employee Retirement Income Security Act of 1974 (ERISA) in accordance with previously issued Department of Labor guidance will satisfy the requirements. The opportunity to divest employer securities must be permitted no less frequently than quarterly.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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