IRS provides anti-cutback relief for certain ESOP amendments

The IRS has issued a notice providing relief from the anti-cutback requirements of Code Sec. 411(d)(6) for plan amendments that eliminate a distribution option from an ESOP that becomes subject to the diversification requirements of Code Sec. 401(a)(35), which apply to certain defined contribution plans that hold (or are treated as holding) publicly traded employer securities.

ESOPs are generally subject to diversification requirements under Code Sec. 401(a)(28)(B). In general, under Code Sec. 401(a)(28)(B)(i), an ESOP must provide certain participants the opportunity to elect to direct the plan as to the investment of at least 25% of the participant’s account. The election must be available to a participant during the 90-day period following the close of each plan year in the 6-plan-year period beginning with the first plan year in which the participant has both attained age 55 and completed 10 years of participation. An ESOP is allowed to satisfy these diversification requirements by, among other means, distributing the portion of a participant’s account that is covered by the election within 90 days after the period during which the election may be made.

Code Sec. 401(a)(35), which was added by the Pension Protection Act of 2006 (P.L. 109-280) requires an “applicable defined contribution plan” to meet different diversification requirements with respect to investments in employer securities. These requirements cannot be satisfied by distributing a portion of the participant’s account. An ESOP that holds employer securities that are readily tradable on an established securities market is an “applicable defined contribution plan” that is subject to the requirements of Code Sec. 401(a)(35) if either: (1) the ESOP is not a separate plan but rather is a portion of a larger plan or (2) the ESOP holds contributions that are or were subject to Code Secs. 401(k) or 401(m).

In the notice, the IRS addresses the situation where an ESOP that satisfied the diversification requirements of Code Sec. 401(a)(28)(B)(i), by allowing distribution of a portion of a participant’s account, has become subject to the diversification requirements of Code Sec. 401(a)(35). As a result of becoming subject to Code Sec. 401(a)(35), the distribution options of Code Sec. 401(a)(28)(B) no longer apply. For such ESOPs, some in-service distribution options used to satisfy the diversification requirements under Code Sec. 401(a)(28)(B) are no longer permissible.

The relief provided by the notice allows the ESOP to be amended to eliminate all in-service distribution options previously used to satisfy the diversification requirements of Code Sec. 401(a)(28)(B)(i). The relief applies to amendments that are both adopted and put into effect under a plan by the last day of the first plan year beginning on or after January 1, 2013, or by the time the plan must be amended to satisfy Code Sec. 401(a)(35), if later.

Where an ESOP has been timely amended to satisfy Code Sec. 401(a)(35) and the remedial amendment period with respect to that amendment expires before the ending date of 411(d)(6) relief, the notice also extends the remedial amendment period to the last day of the first plan year beginning on or after January 1, 2013, to permit the adoption of an amendment to the ESOP eliminating a distribution option described in Code Sec. 401(a)(28)(B)(ii)(I).

Source: IRS Notice 2013-17.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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