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One-Time Diversification Window


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For various reasons, a client wants to do a one-time diversification in it's ESOP where the company buys stock from participants up to a certain limit.

We know this can be done, but we don't know a couple details.

First, can we do it so only vested shares are redeemed? If so, how would we allocate who gets to redeem what? Is it based only on their vested account or is it based on their entire account balance?

Second, can we do age-weighted allocation, so older participants can diversify more than younger participants? If so, what are the traps? Is this a discrimination issue?

Third, can we do diversification in the three typical ways (1) distribution, (2) cash in the ESOP, (3) cash to another qualified plan?

If anyone knows of any guidance I can use to help find answers to these questions, please let me know! Thank you in advance!

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You need to evaluate availability of in-service distributions under in-service distribution rules (and be careful about creating protected benefits). The ESOP diversification rules do not give you a pass except in accordance with those rules.

This makes sense. Do those rules matter if we are just swapping shares for cash in the ESOP or transferring cash to another qualified plan?

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The standard diversification rules are a minimum. You can be more generous. I don't recall every seeing someone do something as complex as you are talking about.

I have seen a one time diversification for anyone over the age of 45 can take up to 25% of their share balance for example. I have not 25% at 45 to 50 and 35% for age 50 to 55 for example. My reaction is you would have to test something like nondiscrimination.

I would only allow it for vested shares if the cash is leaving the plan-- I guess are you planning on allow them to invest the cash inside the ESOP? If so are the investments going to be participant directed? If so, I would recommend rethinking that. Any more participant directed investments are subject to all kinds of fee disclosures and so forth. Very few ESOPs are equipped to meet those requirements. On the other hand the 401(k) provider most likely meets those requirement already. So sending the money to the related 401(k) plan can solve all kinds of problems. Same with letting the money leave the plan to an IRA or the person.

This would obviously take a plan amendment. I would get a good ERISA attorney to talk to you about any possible problems of doing this only once or on a regular basis. You really want to make sure it doesn't look like you only open up these windows when HCEs would benefit for example.

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