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The Pension Protection Act of 2006
By David Binns, Beyster Institute Staff
 
President Bush recently signed into law the Pension Protection Act of 2006 (PPA) which introduces comprehensive reform of the laws governing tax-qualified plans. Certain components of this law affect ESOPs and other defined contribution plans holding employer securities and will require plan amendments and modifications in qualified plan operations. This article summarizes the key PPA changes affecting ESOPs and the use of employer securities in qualified benefit plans.
EGTRRA Sunset Provisions Made Permanent
Several provisions applicable to ESOPs from the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) were subject to a “sunset” provision whereby they were scheduled to expire at the end of 2010. PPA makes these provisions permanent. These provisions include the prohibited allocation provisions of Code Section 409(p) (the anti-abuse provisions applicable to S corporation ESOPs), and the Code Section 404(k) deduction for ESOP dividends reinvested in employer stock. The dividend reinvestment provisions primarily benefit publicly traded companies that sponsor stand-alone ESOPs and ESOPs integrated with 401(k) plans.
Diversification Requirements for Publicly Traded Companies
Under PPA, defined contribution plans that hold publicly traded employer securities must provide plan participants with new diversification rights enabling participants and certain beneficiaries to direct that the portion of their accounts invested in employer stock be reinvested in other investment options. The timing of these requirements is different depending on whether the contributions were based on elective deferrals, employee after-tax contributions or employer matching contributions that are invested in employer stock.
To be exempt from these requirements, an ESOP must be a stand-alone plan that is not integrated with any other defined contribution plan, and must not hold contributions that are subject to employee deferrals or employer matching contributions.
ESOPs in closely-held companies are not subject to the diversification requirements.
To meet the new diversification requirements, plans must permit participants to direct that employer stock acquired via elective deferrals or employee after-tax contributions be invested in alternative investments. Non-elective employer contributions and employer matching contributions held in employer stock may be subject to a 3-year vesting requirement before they become subject to the diversification requirement.
A transition rule applies to amounts attributable to employer contributions invested in employer stock that are acquired before plan years beginning in 2007. For 2007, 33 percent of such amounts will be subject to diversification, increasing to 50 percent in 2008 and 100 percent in 2009. However, participants who are age 55 and have completed three years of service before plan years beginning after December 31, 2005 must be given the opportunity to diversify some or all of the employer stock held in their accounts.
To meet the diversification requirements, participants must be provided with at least three diversified investment options other than employer stock. Diversification options must be provided at least quarterly and at least as frequently as other investment changes permitted under the plan. In addition, the plan may not provide less favorable treatment to employees electing the diversification option.
The diversification provisions are effective for plan years beginning after December 31, 2006. Special effective dates apply to plans subject to collective bargaining agreements and for plans with employer matching and non-elective contributions invested in employer preferred stock as of September 17, 2003.
Accelerated Vesting
PPA requires accelerated vesting for all employer contributions to defined contribution plans beginning in 2007. Employer contributions must be subject to 100 percent cliff vesting after a participant completes three years of service, or must provide for graded vesting in which a participant is at least 20 percent vested after two years of participation, increasing 20 percent per year so that a participant is 100 percent vested after six years.
An ESOP with an outstanding securities acquisition loan in effect on September 26, 2005 may defer compliance with the new vesting requirements until the date the loan is fully repaid or the date the loan was scheduled to be repaid as of September 26, 2005, whichever is earlier.
©2006. The Beyster Institute and its authors and their entities. All rights reserved.
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