Internal Revenue Code Section 401(a)(28) requires an Employee Stock Ownership Plan (ESOP) to allow certain 55-year-old participants the opportunity to elect to direct the plan as to the investment of at least 25 percent of the participant’s account. This ESOP diversification requirement can be satisfied by distributing a portion of the participant’s account, even if the plan might otherwise be restricted from distributing plan benefits before the termination of employment or the occurrence of certain other events.

Code Section 401(a)(35), which was added to the Code by the Pension Protection Act of 2006, also prescribes investment diversification requirements for qualified retirement plans that allow investments in employer securities. Section 401(a)(35), however, applies to an ESOP only if the ESOP holds employer securities that are readily tradable on an established securities market and the ESOP either is a portion of a larger plan or holds contributions that are or were subject to Section 401(k) or 401(m). The section 401(a)(35) diversification requirements cannot be satisfied by distributing a portion of the participant’s account.

The diversification requirements of Section 401(a)(28) do not apply to an ESOP that becomes subject to the diversification requirements of Section 401(a)(35). So, what happens when an ESOP later becomes subject to 401(a)(35) and no longer is subject to the 401(a)(28) diversification requirements? In that case, the ESOP must comply with applicable rules restricting the distribution of plan benefits before the termination of employment or the occurrence of certain other events. Does an amendment eliminating the 401(a)(28) distribution option violate the anti-cutback rules of 411(d)(6)?

Recently published Internal Revenue Service Notice 2013-17 provides an answer. An amendment eliminating the 401(a)(28) distribution option will not violate the anti-cutback rule as long as the amendment is both adopted and put into effect by the last day of the first plan year beginning on or after January 1, 2013, or by the time the ESOP must be amended to satisfy Section 401(a)(35), if later. In cases where ESOPs have been timely amended to satisfy Section 401(a)(35) and the remedial amendment period with respect to that amendment expires before the ending date of Section 411(d)(6) relief, Notice 2013-17 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 ESOPs eliminating a 401(a)(28) distribution option.