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Hardship withdrawals from ESOP?


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#1 hapa123

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Posted 21 September 2001 - 06:32 PM

Can ESOPs be drafted to permit in-service hardship withdrawals? I found one authority supporting such withdrawals -- Rev Rul 71-224 -- but it is dated.

#2 RLL

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Posted 21 September 2001 - 07:56 PM

Hi hapa123 ---

As a stock bonus plan, an ESOP may provide for in-service hardship distributions the same as a profit sharing plan. Nothing has changed in this regard since 1971. But, if the ESOP includes a money purchase pension plan, that portion of the ESOP may not have pre-retirement in-service hardship withdrawals.

In the case of a closely-held company ESOP, however, the repurchase obligation that arises in connection with benefit distributions may limit hardship distributions to the extent there is not sufficient liquidity in the ESOP or the company.

#3 QDROphile

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Posted 22 September 2001 - 11:36 AM

Let me offer a refinement on RLL's comment. The liquidity problem goes to the wisdom of having a hardship distribution provision in the plan. If it has one, the plan must distribute and the company must honor the put option. In that sense, the liquidity problem is the company's problem, not a limit on the plan's ability to distribute. Perhaps one could design a hardship distribution feature to be limited to times when the plan had adequate cash to make the distribution in cash. I would not try such a provision.

#4 GBurns

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Posted 22 September 2001 - 02:47 PM

hapa123

You referred to a Rev Ruling but then added "but it is dated". What did you mean?

#5 RLL

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Posted 24 September 2001 - 12:01 PM

QDROphile ---

You referred to "a hardship distribution feature to be limited to times when the plan had adequate cash" and then said that you "would not try such a provision."

Such a limitation on hardship distributions is not uncommon in the many closely-held company ESOPs that do include a hardship distribution feature. In my experience, the IRS has never declined to issue a determination letter to an ESOP which includes such a provision.

Why would you "not try such a provision" ? If there's a determination letter and the ESOP fiduciaries apply the feature in a non-discriminatory manner, there should be no concern under the IRC or ERISA.

#6 GBurns

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Posted 24 September 2001 - 03:39 PM

Why would a determination letter from the IRS have any relationship to a hardship withdrawal feature (whether a practical provision or not)?

I also would not try such a provision, not only for the difficulty of applying iit n a non-discriminatory manner, but timimg issues, availability of funds issues and record keeping and payback issues. I see administrative nightmares.

#7 RLL

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Posted 24 September 2001 - 03:58 PM

GBurns ---

What recordkeeping and payback issues? We're talking about hardship withdrawals, not participant loans.

Many ESOP companies have implemented hardship (and other in-service) withdrawal features and have not been faced with "administrative nightmares." If a company really wants an in-service withdrawal feature in its ESOP, the administrative issues are not very difficult. I see very little difficulty for a fiduciary in applying a standard of non-discrimination to a plan feature. Availability of funds is the very limitation that we were addressing....if there are no funds available, there are no hardship distributions.

In advising companies on the design of an ESOP, I've always thought that it was better for a professional to explain to a company how to do what it wants to do....so long as it's legal....while pointing out the risks, problems, issues, etc., involved....and then letting the company decide whether it wants to include the feature in the ESOP. I believe this approach is preferable to just saying "No, you can't (or shouldn't) do that...it's too hard to administer, etc....."

My reference to an IRS determination letter was in response to QDROphile's comment that he/she would not "try" such a provision. I assumed (maybe incorrectly) that he/she thought that there may be a qualification issue with the provision that he/she described.

#8 QDROphile

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Posted 25 September 2001 - 11:20 AM

I realize that in ESOP land that it is allowable to have a provision that is applied circumstantially. But even though it may be legal (for policy reasons that are questionable), that doesn't make it a good idea. First, it puts additional responsibility on the adminstrator to make sure it is applied correctly. Second, I think it is a bad idea to tell participants, "Maybe you can, maybe you can't, and we can't tell you in advance if the feature is available." Generally I am uncomfortable with all the the special vague rules under ESOP lore. I prefer more solid authority than anecdotal evidence that someone in the IRS didn't take issue.

#9 RLL

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Posted 25 September 2001 - 11:55 AM

QDROphile ---

While you may be uncomfortable with what you refer to as "special vague rules under ESOP lore," I'm very uncomfortable with any approach that advises, in effect, that "You can't do what you'd like to do...even though many other ESOPs do it...even though the IRS OKs it...even though your employees want it...because I'm not sure what the rules are."

ESOPs have been utilized for more than 40 years and have been specifically recognized under the IRC and ERISA for 27 years. After all this time, there is certainly enough legal/regulatory authority and practical experience for ESOP companies to be adequately informed by knowledgable advisers regarding plan design features that are available, including the advantages, disadvantages, problems, risks, alternatives, etc., that should be considered.

You may think that the policy reasons for allowing flexibility/creativity in the design and operation of ESOPs are "questionable," but it's very clear that it is Congress that has largely been responsible for creating "ESOP land" (as you call it) by repeatedly (since 1973) enacting significant incentives to promote employee ownership through ESOPs.