Basic ESOP Distribution Rules

Transcription

1 Basic ESOP Distribution Rules Midwest ESOP Conference September 12, 2014 Scott J. Freund, QPA Blue Ridge ESOP Associates Timothy L. Stewart DeWitt Ross & Stevens

2 Welcome to our Session! Introductions Today s Topics Distribution Requirements Distribution Policies and Case Studies Diversification 2

3 Distributions Timing When the distribution will begin Method The manner in which the distribution will be paid (Lump sum or Installments) Form Cash, stock or a combination of both 3

4 Distributions Timing General ERISA Requirements Internal Revenue Code (IRC) Section 401(a)(14) Distribution must commence no later than the 60 th day after the end of the plan year in which the latest of the following occurs: Earlier of age 65 or the plan s normal retirement age The 10 th anniversary of the date on which the participant began participating in the plan Termination of the participant s service 4

5 Distributions Timing General ERISA Requirements IRC Section 401(a)(14) Rules governing early retirement benefits IRC Section 401(a)(9) Required minimum distributions Age 70 ½ Death 5

6 Distributions Timing Accelerated ESOP Distribution Rules IRC Section 409(o) Apply to stock acquired by an ESOP after 1986 Retirement, death or disability End of the plan year following the plan year in which the event occurs Other termination End of the sixth plan year following the plan year in which employment terminates (unless reemployed) 6

7 Distributions Timing Accelerated ESOP Distribution Rules Exception for leveraged ESOPs Distributions attributable to leveraged shares may be delayed until the plan year following the plan year in which the loan is repaid Applies only to C-Corporations? General ERISA Requirements may require an earlier payment 7

8 Distributions Timing Notice and Consent Notice Requirements Notice provided between 30 and 180 days before the date of distribution 30 day waiting period can be waived Consent required For any distribution before the later of age 62 or the plan s normal retirement age, if vested balance exceeds $5,000 If vested balance exceeds $1,000 automatic rollover rules apply (unless plan limits cash-out amount to $1,000) 8

9 Distributions - Method Lump Sum distributions may be made in a single lump sum Installments Must occur in a substantially equal series of installments (not less frequently than annually) Over no more than 5 years (can be as many as 6 installments) Extension for large balances One additional year (but not more than 5 additional years) for each $210,000 or fraction thereof by which the participant s balance exceeds $1,050,000 (indexed) 9

10 Distributions - Form Cash Stock - a participant has a right to demand stock Exceptions Charter or bylaw provision that restricts substantially all stock ownership to the ESOP or current employees S corporation May still distribute employer securities subject to the requirement that the shares be immediately resold to the employer or ESOP Banks Put Option 10

11 ESOP Distribution Policies What is a Distribution Policy? An ESOP Distribution Policy is the specific rules developed by the Plan Sponsor and/or ESOP Committee that describe when and how distributions from the plan will occur May be included within the plan document or in a separate distribution policy document IRS may request distribution policy document as part of a determination letter review process 11

12 ESOP Distribution Policies (Cont.) When an ESOP is adopted, the development of the distribution policy depends on: Repurchase liability and cash flow projections Lender/Third Party covenant requirements Leveraged vs. Non-Leveraged ESOP C vs. S Corporation Benefit amount/allocation issues Impact on company s financial statements Participant tax issues Legal Considerations (i.e. counsel s view of what should be included in the plan and what is appropriate for inclusion in a separate distribution policy) 12

13 ESOP Distribution Policies (Cont.) During the life of the ESOP, changes to the distribution policy or the plan may be appropriate or necessary if the initial distribution policy/plan design considerations have also changed Limitations on Right to Change Distribution Policies/Plan Document Distribution Provisions Fiduciary Responsibility of Trustee/ESOP Committee Code Section 411(d)(6) Anti Cutback Rule The Anti Cutback Rule prohibits a reduction in any accrued benefit by a plan amendment Accrued benefits include the timing, method and form of distributions However, there is an exception to the Anti Cutback Rule which applies specifically to ESOPs 13

14 ESOP Distribution Policies (Cont.) ESOP Exception to the Anti Cutback Rule Statute Regulations Code Section 411(d)(6)(C) provides there is not a violation of the anti cutback rules when distribution options in an ESOP are modified in a nondiscriminatory manner ESOPs can eliminate or retain discretion to eliminate: Lump sum or installment forms of distribution Stock distributions if employer becomes substantially employee owned or an S Corporation Cash distributions when employer s stock becomes publicly traded 14

15 ESOP Distribution Policies (Cont.) Recommended steps prior to modification of an ESOP Distribution Policy Update Repurchase Liability Study Review short and long-term cash flow projections S corporations Analyze impact on 409(p) testing Consider general non-discrimination and fiduciary requirements Review/analyze HR considerations Provide advance notice of changes to plan participants 15

16 Distribution Policy Example #1 Goal #1 Commence distributions to pay terminated participants as soon as feasible in the year following termination Goal #2 Maintain current ESOP ownership Goal #3 Utilize allocated cash in the trust to fund distributions 16

17 Distribution Policy Example #1 Timing: Death: distributable as soon as practicable following the participant s death Disability, Retirement and other Termination: distributable as soon as practicable following the end of the plan year in which the participant s employment ceased Form: Distribution of the vested participant account balances will be made in the form of cash unless a participant requests distribution in the form of Employer Securities Method: All distributions made in a lump sum 17

18 Distribution Policy Example #1 Possible Issues Ensuring sufficient cash in the plan to fund lump sum distributions Company contributions (subject to 415 limits) Dividends/S corp. distributions Getting the stock back into the plan if a participant elects a stock distribution When the shares are put back to the company, deposit them back in the ESOP as a stock contribution Have the ESOP satisfy the participant s put rights in place of the company 18

19 Distribution Policy Example #2 Goal #1 Provide a benefit to disabled participants and beneficiaries of deceased participants as quickly as possible Goal #2 Delay distributions of stock accounts of terminated participants tied to an ESOP loan Goal #3 To discourage employment termination due to size of ESOP account balances 19

20 Distribution Policy Example #2 Timing: Death and Disability: 50% of the most current account balance shall be paid as soon as administratively possible after the date of death or disability. The remainder shall be paid as soon as administratively possible after the allocation has been completed for the plan year of termination Retirement: distributable as soon as practicable following the end of the plan year in which the participant s retirement occurred Other Termination: distributable as soon as practicable in the 6th plan year following the plan year in which employment ceased Leveraged Securities: If the Participant s separation from service is due to any reason other than death, disability, or attainment of Normal Retirement Age, Company Stock held in the Participant s Company Stock Account that was acquired with an Acquisition Loan may not be distributed until the Acquisition Loan has been repaid in full 20

21 Distribution Policy Example #2 Form: Distribution of the Participant s vested Account Balance will be processed by distributing stock Method: Death and Disability: vested account balances will be made in a lump sum payment Retirement and Termination: vested account balances will be made in a lump sum payment if the Participant's vested Account balance at the time of distribution does not exceed the Lump Sum Threshold set by the Employer for the year of the distribution. If a Participant's vested Account balance exceeds the Lump Sum Threshold, distributions will be made in substantially 5 equal annual installments 21

22 Distribution Policy Example #2 Possible Issues Further delaying distributions to terminated participants beyond ESOP Loan Repayment by using installment method HR Issue: Will benefit delayed so long be meaningful? Increase in plan expense costs due to multiple distributions being paid to the same participant Not being able to locate former participants when they are due a distribution Impact on Repurchase Liability Processing installments when the participant does not make a subsequent election Any distributions that are processed via the installment method will have the subsequent annual installments processed during this same annual distribution processing period based on the original distribution election, unless a new distribution election form is completed 22

23 Distribution Policy Example #3 Goal #1 Control and manage company cash flow Goal #2 Commence installment distributions within a reasonable time frame and give plan administrator ability to accelerate payments when cash flow permits 23

24 Distribution Policy Example #3 Timing: Death, Disabled and Retired Participants: Paid in the year following the year of termination Other Termination: Same rules would apply for participants that leave for reasons other DDR, except if the installment payment option is selected by the Plan Administrator, their distributions won t commence until their 3rd year following termination of service Form: Since the ESOP is sponsored by a company that is an S Corporation, all distributions will be paid in cash Method: If the Plan Administrator does not have sufficient cash in the ESOP to make lump sum distributions, the following installment provisions will apply: Vested balances of $10,000 or less paid in lump sum Vested balances of $10,000 - $20,000 paid in 2 installments Vested balances of $20,000 - $30,000 paid in 3 installments Vested balances of $30,000 - $50,000 paid in 4 installments Vested balances above $50,000 paid in 5 installments 24

25 Distribution Policy Example #3 Changes to Policy The Plan Administrator may not be able to process initial lump sum distributions, but does have sufficient cash in later years to accelerate the installment amounts The ESOP has excess cash to process installment distributions more than the standard threshold amount in one given year 25

26 Distribution Policy Example #3 Changes to Policy (Cont.) Potential Change in Policy: Impose additional delay on commencement of installment distributions Could plan administrator re-apply six (6) year delay in making distributions if installments already started? Example: Terminated participant with $50,000 balance got $10,000 installment 3 years after termination Now remaining installments to be paid in years 6-9 instead of 4-7 Permitted by 411(d)(6), but comply with 409(o)(1)(C) which requires substantially equal annual installments? Arguably no 26

27 Traditional Diversification Who is eligible for diversification? Age 55 Ten years of participation All plan years in which a participant has an account balance Only plan years in which a participant is eligible for contributions and forfeitures Be specific in plan document 27

28 Diversification Timing of Election Participant must elect within 90 days following the end of the plan year ESOP trustee has 90 days after the election period to satisfy the diversification election Can diversify up to 50% over a six year period Can diversify up to 25% of shares ever allocated to the account (cumulative) over the first five years Can diversify an additional 25% of shares ever allocated to the account (cumulative) in the sixth election year 28

29 Diversification Satisfying the Election Offer three or more alternative investment funds within the ESOP Offer a transfer to a sister qualified plan that offers three or more alternative investment funds Distribute cash equal to stock value Distribute stock (subject to the put option in a closely held company) 29

30 Diversification Example Susan attains age 55 during the 2008 plan year Her tenth year of participation is met in the 2010 plan year First election period January 1, 2011 March 31,

31 Diversification Calculation Example Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Beginning shares 1, New shares allocated Plus shares previously diversified Subtotal 1, , , , , ,200.0 x25% (years 1-5) (50% year 6) Less shares previously diversified Shares eligible for diversification Shares diversified Balance after diversification

32 Questions? 32