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Anti-cutback Relief from IRC Section 411(d)(6) for Certain ESOP Amendments
Practical Law Legal Update 6-525-8906 (Approx. 5 pages)
Anti-cutback Relief from IRC Section 411(d)(6) for Certain ESOP Amendments
by PLC Employee Benefits & Executive Compensation
| Published on 23 Apr 2013 • USA (National/Federal) |
On April 18, 2013, the IRS issued Notice 2013-17, which provides relief from the anti-cutback rules of Section 411(d)(6) of the Internal Revenue Code (IRC) for plan amendments that eliminate a distribution option from an employee stock ownership plan (ESOP) that becomes subject to the diversification requirements of IRC Section 401(a)(35), which applies to certain defined contribution plans that hold publicly traded employer securities.
On April 18, 2013, the IRS issued Notice 2013-17 (Notice). The Notice:
- Provides relief from the anti-cutback rules of Section 411(d)(6) of the Internal Revenue Code (IRC) for plan amendments that eliminate a distribution option from an employee stock ownership plan (ESOP) that becomes subject to the diversification requirements of IRC Section 401(a)(35), which applies to certain defined contribution plans that hold publicly traded employer securities. This relief allows amendment of an ESOP to eliminate all in-service distribution options previously used to satisfy the diversification requirements of IRC Section 401(a)(28)(B)(i).
- Addresses circumstances in which an ESOP that satisfies the diversification requirements of IRC Section 401(a)(28)(B)(i) by allowing distribution of a portion of a participant's account becomes subject to the diversification requirements of IRC Section 401(a)(35).
- Addresses the deadline by which an amendment to comply with IRC Section 401(a)(35) may be adopted without violating IRC Section 411(d)(6) if the amendment is adopted by a certain date and other requirements under the Pension Protection Act of 2006 (PPA) are met.
Diversification Requirements
An ESOP may be subject to diversification requirements under either:
- IRC Section 401(a)(35), which:
- was added to the IRC by the PPA; and
- is effective for plan years after December 31, 2006.
An ESOP that is an "applicable defined contribution plan" (as defined below) ceases to be subject to the diversification requirements of IRC Section 401(a)(28) and must satisfy the diversification requirements of IRC Section 401(a)(35).
IRC Section 401(a)(28)
The diversification rules under IRC Section 401(a)(28)(B) require that an ESOP provide to participants who are at least age 55 and have at least 10 years of participation (qualified participants) an opportunity to diversify their plan holdings that consist of employer securities. To meet this requirement, the ESOP must permit these participants to direct the investment of a certain percentage of the employer securities held in their ESOP accounts into other investment options during the first 90 days of each of the six plan years beginning after the participant becomes a qualified participant.
IRC Section 401(a)(28)(B)(ii) permits an ESOP to satisfy these requirements by distributing to the participant the portion of the participant's account subject to the diversification requirement within 90 days after the period in which the diversification election may be made.
IRC Section 401(a)(35)
IRC Section 401(a)(35) requires that defined contribution plans that hold publicly traded employer stock provide diversification rights for amounts invested in employer stock. An ESOP that holds employer stock that is not publicly traded is not subject to this diversification requirement. An ESOP that holds employer securities that are readily tradable on an established securities market is an "applicable defined contribution plan" and subject to the requirements of IRC Section 401(a)(35) if the ESOP either:
- Is not a separate plan but is a portion of a larger plan.
- Holds IRC Section 401(k) or 401(m) contributions (elective deferrals, employee after-tax or employer matching contributions).
An ESOP that is an applicable defined contribution plan ceases to be subject to the diversification requirements of IRC Section 401(a)(28)(B) and must satisfy the diversification requirements of IRC Section 401(a)(35).
An ESOP subject to IRC Section 401(a)(35) is generally required to offer at least three alternate investment options that are diversified and that offer materially different risk and return characteristics. The diversification requirements of IRC Section 401(a)(35) cannot be satisfied by distributing a portion of the participant's account as permitted under IRC Section 401(a)(28).
Anti-cutback Rules of IRC Section 411(d)(6)
Under IRC Section 411(d)(6)(A), an amendment to a plan may not decrease a participant's accrued benefit. IRC Section 411(d)(6)(B) provides that a plan amendment that has the effect of eliminating an optional form of benefit with respect to benefits attributable to service before the amendment is treated as reducing accrued benefits. An ESOP is not treated as failing to meet these requirements because it modifies the distribution options in a nondiscriminatory manner.
Notice 2013-17
The Notice generally provides that it is not a violation of the anti-cutback rules of IRC Section 411(d)(6) for an ESOP that:
- Satisfies the diversification requirements of IRC Section 401(a)(28)(B)(i) by distributing a portion of a participant's account.
- Becomes subject to the requirements of IRC Section 401(a)(35).
- Is amended to eliminate the distribution option previously used to satisfy the diversification requirements of IRC Section 401(a)(28)(B)(i).
Amendments
Provided certain PPA requirements are met, the IRC Section 411(d)(6) relief applies to amendments that are both adopted and put into effect under a plan by the later of:
- The last day of the first plan year beginning on or after January 1, 2013.
- The time the plan must be amended to satisfy IRC Section 401(a)(35).
For more information on IRC Section 411(d)(6), see Practice Note, Protected Benefits under IRC Section 411(d)(6).