Co-authored by Ann M. Kim

On May 19, the Internal Revenue Service issued final regulations that clarify when public companies must allow plan participants to voluntarily divest employer stock allocated to their retirement plan accounts. The regulations only apply to public companies that maintain defined contributions plans (typically referred to as 401(k) plans or profit-sharing plans) where employer stock is an available investment alternative. The regulations require that, subject to certain limited exceptions, participants must always be able to move their own contributions (including rollover contributions) out of employer stock funds. In addition, employer contributions must be eligible for movement from the employer stock fund once the participant has provided three years of service to the company.

The regulations finalize rules first enacted by Congress in 2006. The Pension Protection Act of 2006 required greater diversification rights for public employer stock funds in order to address situations where a company’s stock was falling but retirement plan participants were powerless to diversify their accounts and minimize their losses. While the increased flexibility helps participants who will no longer be locked in to one, undiversified investment, the new rules can also help plan fiduciaries avoid liability for maintaining the stock fund in times when the value is declining.

In order to comply with the final regulations, retirement plans must have at least three other diverse investment alternatives available under the plan (although, plans typically have many more alternatives). In addition, the plan cannot impose any direct or indirect conditions on investment in, or divestment of, employer stock that do not apply to other plan investment alternatives. For example, with limited exception, the final regulations would not permit a restriction that permanently prohibits amounts from being reinvested in employer stock if it was previously divested from employer stock.

While interim diversification guidance is currently in effect, the final regulations become effective for plan years beginning on and after January 1, 2011.

The final regulations can be found here.