Client Alert from the Employee Benefits & Executive Compensation Practice: Update on New Developments

June 3, 2010

Final Regulations on Diversification Rule for Defined Contribution Plans Holding Employer Securities  

The Internal Revenue Service has issued final regulations governing the diversification requirements for defined contribution plans that hold publicly-traded employer securities.

Before enactment of the Pension Protection Act of 2006 (PPA), there were few restrictions on investments by defined contribution plans in employer securities, except for ESOPs.

PPA established diversification requirements for participants in certain defined contribution plans. For the portions of a participant’s account attributable to employee contributions and elective deferrals that are invested in employer securities, the plan must allow the participant to direct the plan to divest the employer securities and reinvest an equivalent amount in other investment options.

For the portion of employer contributions other than elective deferrals that are invested in employer securities, the same diversification rights must be given to each participant who has at least three years of service (or to the beneficiary of such a participant).

The final regulations are effective for plan years beginning on and after January 1, 2011. Before then, a plan may rely on IRS Notice 2006-107, the proposed regulations, or the final regulations.

EBSA Announces Changes to Form 5500 Electronic Filing Procedures  

The U.S. Department of Labor’s Employee Benefits Security Administration has announced a new e-signature option as part of its EFAST2 electronic filing system for Forms 5500 and 5500-SF employee benefit plan annual reports.  Now, service providers that manage the 5500 filing process for plans can get their own signing credentials and submit the electronic Form 5500 or 5500-SF for the plan.

All users of EFAST2 must establish their credentials, whether as the filing author, the signer, a schedule author, or the transmitter. With respect to the signer, EBSA has stated that a plan administrator should not share a registration login with the preparer so that the preparer can sign the form; rather, a plan administrator must examine a return before it is submitted, and the administrator’s signature attests that this has been done, and that to the best of his/her knowledge and belief, the return is true, correct, and complete.

Agencies Issue Interim Final Rules Regarding Health Coverage of Adult Children  

The Internal Revenue Service, the Department of Labor, the U.S. Department of the Treasury, the Employee Benefits Security Administration, the Office of Consumer Information and Insurance Oversight, and the U.S. Department of Health and Human Services have jointly issued interim final rules providing guidance on the provision of health coverage to adult children.(

The Patient Protection and Affordable Care Act requires group health plans and insurance policies offering dependent care coverage to extend coverage to adult children, without regard to marital status, until the age of 26.  Plans are not required, however, to cover the spouse of an eligible child.  Similarly, nothing in the regulations requires coverage of grandchildren.

The interim final regulations generally apply to group health plans and group health insurance issuers for plan years beginning on or after September 23, 2010, and to individual health insurance issuers for policy years beginning on or after September 23, 2010.

The regulations make it clear that plans and policies may not deny coverage to a qualifying adult child merely because the child does not qualify as a tax dependent or a student or does not reside with or receive financial support from the parent. As such, with respect to children who have not attained age 26, a plan or issuer may not define dependent for purposes of coverage eligibility other than in terms of the relationship between the child and the covered individual.

The interim final rules further make it clear that the terms of the plan or policy for dependent coverage cannot vary based on the age of the child, except for children age 26 or older. Accordingly, surcharges for coverage of children under age 26 are not allowed except where the surcharges apply without regard to the age of the child (up to age 26) and that, for children under age 26, the plan cannot vary benefits based on the age of the child.

The adult child dependent coverage extension requirement generally applies equally to “grandfathered plans.” (Grandfathered plans, as defined by the health care legislation, are exempt from certain requirements imposed by the new law.)  However, for plan years beginning before January 1, 2014, the interim final regulations provide that a grandfathered group health plan that makes available dependent coverage of children may exclude an adult child who has not attained age 26 if the child is eligible to enroll in an employer-sponsored health plan other than a group health plan of a parent. In the case of an adult child who is eligible for coverage under both parents’ plans, the regulations clarify that neither plan may exclude the adult child from coverage based on the fact that the adult child is eligible to enroll in the plan of the other parent’s employer.

The regulations provide transitional relief, including notice and an opportunity to enroll, designed to deal with situations where the adult child had previously aged out of coverage, or was denied coverage due to attainment of an age before age 26.

DOL and SEC Provide Informal Guidance Regarding Target Date Funds  

The U.S. Department of Labor (DOL) and the SEC have jointly issued guidance designed to help investors (including plan participants) to better understand the operations and risk of target date fund investments and to better evaluate such funds.

The guidance, issued in the form of an Investor Bulletin reminds plan participants and non-participant investors alike that while various target date funds may share the same target date, for example 2020, they may nevertheless have very different investment strategies and risks. Moreover, the Bulletin reminds investors that target date funds do not guarantee that the investor will have sufficient retirement income at the target date, and that investors can lose money in a target date fund just the same as in any other investment.

Two New Studies Back Use of Annuities in Defined Contribution Retirement Plans  

There are signs that defined contribution plans could be “encouraged” by the Internal Revenue Service, the U.S. Department of Labor, and new legislation to offer defined contribution plan participants the opportunity to annuitize part or all of their account balances when they retire.  The idea is to help insure that plan participants will have enough income to live on after retirement. A recent Government Accountability Office (GAO) report titled “Retirement Income: Challenges for Ensuring Income throughout Retirement” steers in that direction. And an in-depth study by the American Council of Life Insurers (ACLI) squarely supports the annuitization option. Both the GAO report and the ACLI study respond to an IRS/DOL request for information on how plans can boost the chance that defined contribution plans will provide participants with lifetime income.   

IRS Describes Form Changes Necessitated by HIRE Act  

The “Hiring Incentives to Restore Employment Act”  encourages companies to hire unemployed workers by exempting certain wages from Social Security taxes (payroll tax exemption), and by providing employers with a business tax credit if new hires are retained for at least 52 consecutive weeks. The Internal Revenue Service (IRS) has now explained changes to various tax forms necessitated by the legislation:

Form 941. The IRS will be revising the second quarter Form 941, Employer’s Quarterly Federal Tax Return, due on August 2, 2010.

New Form W-11. An employer may not claim the payroll tax exemption unless the new hire certifies by signed affidavit (under penalties of perjury) that he was employed for a total of 40 hours or less during the 60-day period ending on the date the employment begins. The IRS has drafted Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit, to help employers meet this requirement.

Form W-2/W-3. There will be a new code on box 12 of the 2010 Form W-2  to indicate that a new hire had wages that qualified for the payroll tax exemption. Form W-3, Transmittal of Wage and Tax Statements, will be revised to include a line for total aggregate exempt wages.