KSOPs - "primarily invested" rule

[Guest Gail S]

With a KSOP, is the entire plan (both ESOP and 401(k) portion of the plan) required to be primarily invested in employer securities? Is it alright to only have the ESOP portion of the plan primarily invested in employer securities and allow multiple investment options for the 401(k) portion of the plan? I was under the impression that it was okay to treat the 401(k) and ESOP portions of the plan as two separate plans for purposes of the "primarily invested" rule. However, I came across a treatise which says that a KSOP must be designed to invest primarily in employer securities and that all benefits under a KSOP must be distributable in employer stock. Thanks for your suggestions.

[RLL]

Gail S ---

The issue is whether the entire KSOP (both the ESOP portion and the 401(k) portion) is designated as an "ESOP" under IRC section 4975(e)(7).

Are any elective deferrals being invested in employer stock? Are all matching and any employer discretionary contributions invested in employer stock or do participants direct investment of such contributions? Is there separate testing of ESOP and non-ESOP portions under IRC section 401(k) and (m)?

Please better describe the structure of the KSOP....your question can't be answered without more details. And don't believe everything you read in a "treatise".....it may be referring to a different type of arrangement.

[IRC401]

Much of the KSOP activity over the past five years relates to the desire of companies to be able to deduct dividends held in 401(k) or match accounts.

If 401(k) or match accounts are invested in employer stock, the dividends on that stock are tax deductible only if the accounts are held by an ESOP. Therefore, if the employer wants to deduct the dividends, it needs to make certain that the 401(k) and matching portions of the plan are part of an ESOP and comply with all of the ESOP rules, including the primarily invested rule.

If the plan also holds a substantial amount of non-employer stock as assets, the employer may decide to split the k plan into ESOP and non-ESOP portions in order to not have problems under the primarily invested requirement.

Publicly traded companies that have 401(k) plans that invest in employer stock and that pay dividends should be thinking about "KSOPs" in light of the 2001 Tax Act.