ESOP restructuring

[Guest AMK]

A client has an ESOP with a CODA. The client wants to spin off the CODA piece of the plan into a 401(k) plan (the CODA piece is getting too much money so that the ESOP is having trouble with the "primarily invested" requirement). At the end of the day the client ends up with an ESOP and a 401(k) plan bundled together in one document (a KSOP). The ESOP would provide the match (in company stock) for the 401(k) elective deferrals. I believe particiapnts will have the option of investing their 401(k) elective deferrals in company stock. Is such restructuring permissible? Does it raise any issues as to qualification under the Code? What if the piece that the client wants to spin off includes money from elective deferrals (under the CODA) and money from other plans whose assets have been transferred to the ESOP pursuant to acquisitions? Any additional issues? Any help would be appreciated, as would any suggestions for research references.

[RLL]

Hi AMK ---

The restructuring that you describe is certainly permissible under current law, and the proposed KSOP arrangement is not uncommon.

Under the 401(k) regulations, ADP testing (if required) must be done separately for the ESOP and non-ESOP portions of the KSOP. An issue to address is whether 401(k) elective deferrals invested in company stock will be in the ESOP portion or the non-ESOP portion. Is the dividend deduction under IRC section 404(k) a factor?

Another consideration at this time should be the extent to which ERISA and the IRC might be amended this year to place restrictions on 401(k) arrangements (including matching contributions) which provide for investments in company stock.....in light of the concerns raised by Enron.

[Guest AMK]

Yes, dividend deduction is the main concern, as is the ability to pass through the dividends to participants. Many of the participants have been receiving substantial dividends for many years and rely on them as an income supplement. The client wants to maintain those dividends to the greatest extent possible. The client would like to leave the 401(k) contributions currently invested in company stock in the ESOP (rather than spin them off into the 401(k) plan). But wouldn't that raise 414(l) issues? The client would love to be able to pay dividends out to participants on future 401(k) contributions invested in company stock, but how can those contributions be shifted to the ESOP?

[RLL]

AMK ---

I see no 414(l) issues. To obtain the maximum possible 404(k) deduction, the company stock portion of the 401(k) can remain part of the ESOP. The "spin-off" of the 401(k) plan should be limited to the non-company stock assets.