ESOPs

[Guest jcr]

401(a)(28) requires age 55 and ten years of participation to become a qualified participant. May an ESOP be amended to reduce the ten year requirement to nine years and not suffer any negative consequences? Any authority out there?

Thanks.

[mbozek]

I have understood that an employer could always be more liberal than the minimum required under a statutory provision, e.g., employer can provide faster vesting than 5 year cliff/7yr graded with out being disqualified. In the post Enron world this will probably be changed to allow diversification at a far earlier age.

[Guest jcr]

Thanks. I thought that could be the case, but was worried about early diversification affecting the primarily employer securities requirement of ESOPs.

Thanks again.

[mbozek]

According to news reports Enron's ESOP permitted employees to sell Enron stock at age 50.

[RLL]

jcr ---

If you're concerned about the ESOP being invested "primarily" in employer stock by reason of more liberal requirements for diversification, perhaps the ESOP should effect diversification elections through distributions or by transfer of assets to another plan. This would avoid having the diversified assets being held under the ESOP.

mbozek ---

President Bush's proposal for "diversification" elections out of employer stock would apply to an ESOP only to the extent of employer stock which is attributable to 401(k) and 401(m) contributions. Some of the more extreme bills introduced in Congress would require earlier diversification in ESOPs than under current IRC section 401(a)(28)(B), but I think it's a bit too early to predict that the law "will probably be changed to allow diversification at a far earlier age."

[mbozek]

RLL: The reason their will be changes in ESOP diversification was noted a post in the 401(k) plan thread under lesops and esops:

Because the stock can goe to 0 (Polaroid) before the employees can diversify at age 55. In the post Enron world there is no public policy reason for allowing employers to get tax deductions for the contributions of the stock if the value of the stock declines to 0 before the employes can sell it.

[Guest jcr]

Yes, perhaps if the ESOP allows in-service ditributions, but wouldn't that trigger the 10% excise tax if it's a distribution rather than a diversification election?

[RLL]

jcr ---

Of course a distribution may be subject to the 10% additional [not excise] tax on early distributions under IRC section 72(t), even if the distribution is made to satisfy a diversification election under section 401(a)(28)(B). But the tax may be avoided through a rollover to an IRA (or other eligible retirement plan) at the election of the participant.

[mbozek]

This problem can be solved by requiring the plan or employer to purchase a specified amount of stock (10%) from the employee at fmv at a specified time or after number of years or allowing the employee to sell the stock on an established exchange through the plan without a distribution in order to diversify the investments in the plan before retirement age so that the employee will not be left destitute if the stock tanks. There would be no distribution. The proposal is not fool proof (employer who becomes strapped for cash would not be able to buy stock back) but it is better than the present system. A more draconian solution would be to require all ESOP sponsors to keep some of the plan assets in cash at all times to satisfy the request for sales by the employees.

[Guest Harry O]

mbozek,

You say that "in the post Enron world there is no public policy reason for allowing employers to get tax deductions for the contributions of the stock if the value of the stock declines to 0 before the employes can sell it."

Hmmm . . . I wonder if the flip side of this is that perhaps it makes sense to let employers deduct the fair market value of the stock at the time it is distributed to employees? This might make for some interesting financial and tax analysis . . .

I guess I am a bit hard-hearted on this topic. The US has a voluntary pension system. Employers offer their employees a matching contribution in employer stock that must be held for a number of years. No one forces employees to participate in the plan. The investment soured. It happens, unfortunately. (I especially have no patience for those Enron employees who are now whining but who had all or almost all of their OWN money in Enron. No sympathy here. They could of diversified at any time.)

The real disgrace is that the government has driven DB plans to extinction for reasons too numerous to list here. If Enron employees had a more robust DB plan, the pain would be mitigated somewhat.

[Guest jcr]

Thanks for all your help.