Converting 401(k) to KSOP after EGTRRA

[Guest T-BONE]

Would it make sense to convert a 401(k) that matches with employer securities into a KSOP since deductions will be permitted for reinvested dividends pursuant to EGTRRA?

[RLL]

Hi T-BONE ---

It might make sense.....depending on the value of the dividend deduction to the employer, the costs of implementing the participant dividend election process, the complications (and costs) of satisfying the special "ESOP requirements" of the IRC applicable to a KSOP, etc.

[QDROphile]

Anyone care to comment on the current scam (blessed by the IRS in numerous letter rulings) of defining the ESOP as the portion of the plan invested in company stock? The IRS has ruled that even a stock fund that is subject to participant direction can be the ESOP portion. Nice giveaway to publicly traded companies that have company stock in the plan anyway, especially after 2001.

[RLL]

QDROphile ---

Why do you think it's a scam?

For many years it has been common for an employee benefit program to technically constitute a combination of several plans, each of which is separately qualified under IRC section 401(a). See the recent thread on this ESOP message board entitled "termination of (k) portion of KSOP prior to corporate merger."

Why is it a "scam" to design a retirement program in a manner which satisfies corporate employee benefit objectives while at the same time maximizing tax benefits? This is no IRS "giveaway".....it's a recognition of (clearly legal) creativity in plan design.

[IRC401]

Companies were going to considerable lengths to take advantage of 404(k), including forcing participants to take dividend distributions (which seemed to me to be a breach of fiduciary duty) and finding ways to pay out dividends and get replacement contributions back into the plan. Some of the schemes were suitable only for large companies with sophisticated payroll systems.

Congress decided to simplify 404(k). If you want to know why they didn't repeal it, feel free to ask them.

Anyhow, it seems to me that virtually every publicly traded bank, utility, or other company that pays dividends and allows employees to invest 401(k), matching, or some other type of contributions in employer stock should have an ESOP.

[QDROphile]

In addition to the dangers of influencing employees to invest elective deferrals in company stock, I think it is offensive to both the principles and the law of ESOPs to define an ESOP with respect to how each participant decides to invest plan funds rather than by criteria such as employer contributions and employment culture.

Company stock as an investment option is one thing, but making that the defining characteristic for having an ESOP seems like a mockery. Somehow I have the naive notion that there should be a provision in the plan document that specifies that a contribution be made to the ESOP.

Also, odd questions arise because of special exceptions and rules (such as disaggregation) that distinguish ESOPs from other retirement plans. So how do you apply those rules when on Monday a dollar is in the ESOP and on Tuesday it is not because the participant has changed an investment choice? What is left of the policies behind those rules when application depends on how a participant chooses to invest? Or is this just further revealing the artificiality (or hypocrisy?) of putting ESOPs under section 401 in the first place?

[RLL]

Congress has been providing significant new tax incentives for "ownership sharing" programs in the form of ESOPs periodically over the past 27 years. The legal framework for ESOPs has always been quite flexible, and creative professionals have been able to design a wide variety of innovative arrangements which qualify as ESOPs. This is good...as it accomplishes the purpose of promoting employee ownership in U.S. companies.

ESOPs clearly are appropriate vehicles for providing employee benefits under IRC section 401(a), which was never intended to be limited to "conventional" forms of "retirement" plans. In fact, the federal tax law first recognized stock bonus plans (the basic nucleus of the ESOP) for tax-favored treatment in 1921, five years before tax-exemption was extended to pension plans. Likewise, in enacting ERISA in 1974, Congress specifically determined that carving out special exemptions for ESOPs (in order to promote employee ownership) was not inconsistent with the objective of protecting employee benefits.

You may recall that there was a time when "cash or deferred arrangements" were considered "gimmicky," and many professionals were uncomfortable trying to fit such plans under the statutory scheme of section 401(a). Now, after many modifications/improvements in the applicable IRC provisions by Congress and many innovations developed by benefits professionals, 401(k) plans are becoming the most common form of retirement plan in the U.S.

Certainly any type of employee benefit plan (including an ESOP) is subject to possible abuse....but let's not "throw out the baby with the bath water."