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Installment Distributions from an ESOP

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Our ESOP plan document has the typical provision regarding distributions to terminated participants:  last day of plan year following later of reaching age 65, fifth plan year following plan year in which termination occurs, or 10th year of participation.  (There is no outstanding stock loan.)  Distributions to participants with a balance greater than $5,000 take their distributions in equal installments over five years.  We have a window of time following receipt and approval of the valuation for participants to request a distribution.

An issue I've never been able to figure out is what do you do with participants who are entitled to receive an installment distribution, but do not send in paperwork during the window?  We have ex-employees who want to leave their account open because they think the value of the stock is going to go up, which it has in the past.  However,  we also have people who request a distribution one year, but then forget or neglect to do so for subsequent years.  Our recordkeeper/TPA says that their forms are only good for a current distribution, and participants must send in additional paperwork each year to get the subsequent installments.  As you can imagine, this plays havoc with our cash flow projections.  Is this really how it's supposed to work?

Thanks for any guidance out there!

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I am going to start with one of your last questions/issues. 


I work for an ESOP TPA firm and our installment forms are very clear if you do not return a form in the future years you will get sent an installment sent to the same address and in paid the same way as the prior year.  On the last part it means if you asked for your installment to be sent to xyz IRA and never return a form  after the first one all the installments after that will be sent to xyz IRA.   You, or someone at the company, is the Plan Administrator not the recordkeeper/TPA.   I recommend you speak to your ERISA attorney.  if they agree the plan can have the forms say all future installments will be paid as the previously returned form demand it changes.   You drive how the plan works not the TPA/recordkeeper. 


If the person's balance is over $5,000 you can't force them out of the plan.  it is just how the law works.   You can force them out of the company stock while their balance stays in the plan.  This is called segregation in this business.  If your plan allows for it, and if it doesn't talk to your ERISA attorney to get it amended, you can set up a method that allows you to sell the people out of their stock and into cash based investments.  They key here is to give the plan flexibility.   See if your attorney will allow the plan to be written such the company decides who much cash it wants to put into the ESOP to segregate the accounts and describe the method to do so.  Pro rate is the most common method.  For example, if there is $100,000 of shares in terminated employees accounts that can be segregated and the company is only prepared to put $50,000 in cash to fund segregation using a pro rata method all the terminated employees would be forced to sell 50% of the shares in their account.   You can use other methods than pro rata.  We have clients that sell 100% of the stock from the person with the oldest termination date for example.   You go from oldest to newest until the cash runs out.   You just have to make sure the method isn't discriminatory.    A good ESOP TPA can guide you through this. 


You will find many of the people start taking their payments if they know they are going into a cash based investment vs the company stock.  After all they can invest in mutual funds and so forth in an IRA with more control if they do so.  


There are a number of issues you need to investigate before you do this that is too long to write here.  For example. by making them sell the shares and putting them into some kind of cash investment your company has made an investment election for these people.  That means there is a fiduciary liability regarding the investment choice.  Not saying that is a deal breaker as segregation is common in ESOPs.  I am just saying you need to be aware of the risk when making the choice of investment and pick one that helps mitigate the risk. 

Search the NCEO and ESOP Association's websites for the word "segregation".   You will get a large number of hits for information . 

This is the closest I will do to a "sales job" on this board as that is frowned upon here.  Is your TPA/recordkeeper one that is known to specialize in ESOPs?   I am a little surprised that they haven't brought up segregation.   If not, I recommend you get one that is an ESOP shop.  They can do other types of plans- the company I work for does.  But ESOPs have enough unique situations I think you need an ESOP specialist to help guide you through these kinds of situation/planning opportunities.  

Lastly, I would recommend you attend your local ESOP Association chapter meetings- when we are allowed to have conferences and meetings again!   Also, NCEO has weekly webinars.  The NCEO also has a large conference in April.   There will be breakout sessions on segregation at most conferences.   You can learn a lot and speak to other ESOP companies that have done segregation.  If you aren't a member of the NCEO and ESOP Association you should think about joining to access these benefits and learning opportunities.  There will be a wealth of other sessions on ownership culture, repurchase obligations. what to do if you find a mistake......


Sorry if this was a little long. 

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ESOP Guy is correct, a participant only needs to make a distribution election once to comply with the consent requirements for distributions.  All distributions after the first consented distribution does not need a new consent unless the plan provides otherwise.  Normally, I only see this issue with TPAs that only do the administration for a few ESOPs. 

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  • 7 months later...

I'm sorry I have to disagree with @ESOP Guy and @Degrand, distribution elections are only good for 180 days and become stale after that.  That's from my personal experience with ERISA lawyers.  Also, if your ESOP is amended to allow it and your 401(k) also via an addendum to the K plan that sets the terms for the ESOP to 401(k) transfer, you can force out the non electing ESOP participants into your company 401(k), otherwise you must set up a QDIA-like investment within the ESOP for the liquidated and segregated accounts of your former ESOP participants who fail to make a distribution election.  Force outs to the K plan also have the problem of forcing you to essentially fund with an ESOP cash contribution and do recycling within the ESOP which many companies don't have appetite for.  Also force out to K plan requires plan sponsor to fund entire vested and non-vested ESOP balance and transfer the whole account to the K plan where the K plan must assume responsibility for maintaining the vesting percentage and not allow the K participant to withdraw too much from their former ESOP funds.  Takes a mighty K plan TPA to manage that!  The forfeitures of the former ESOP accounts stay in the K plan and become K forfeitures which the company can use to offset the annual cash match to the K plan, if they do a match in cash to the K plan, which many S Corp ESOPs don't cause they do matches in stock to the ESOP.   Anyway, thought I'd give a different perspective.

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  • 1 month later...
1 hour ago, Degrand said:

@Cardscrazy, the consent and the 180 days is only applicable to the start of the distribution.  Consent is not required for each of the installments.  Just like a retirement plan does not need a participant's consent to each pension payment.  

Yup, agree

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