How to treat employer securities in a 401(k) and ESOP that are combined in the same plan document.

[katieinny]

A plan was recently referred to us that combines a 401(k) and an ESOP under the same plan document.

The 401(k) is participant directed and employer securities are an investment option. And, of course, there are the employer securities that are in the plan due to the ESOP.

Are there special rules or pitfalls that I should be aware of relating to the employer securities since the two plans are combined?

The employer would like to eliminate any distinction between the 401(k) employer securities and the ESOP employer securities. He would prefer to treat them all as ESOP shares. Is that do-able? Recommended?

Your thoughts would be greatly appreciated.

[QDROphile]

It is very popular to erase the distiction between the ESOP shares and shares of employer securities in another plan or the non-ESOP part of the plan. It is also a legal abomination, but the IRS allows it. The usual approach is to define the ESOP to include all the employer securities, whether or not the participant has the right to provide instructions concerning the investment of plan assets into or out of employer securities. The ESOP will not be a separate plan. See Treas. Reg. section 54.4975-11(a)(5).

The trend is driven in large part by the desire to be able to deduct dividends on all the employer securities in the plan, not just the real ESOP shares.

[katieinny]

Well, that explains it then. Thank you so much for clearing it up. My instincts were telling me to keep everything separate, but I guess that won't be necessary after all.

[Kirk Maldonado]

This doesn't relate to the blending of the two different types of plans, but it is a common mistake where employee contributions can be used to purchase employer stock.

Was the sale of the employer stock to participants registered with the SEC?

[katieinny]

Kirk, I lost you. What is a common mistake where employee contributions are used to purchase employer stock?

I don't know if the sale of employer stock to participants was registered with the SEC. Sounds like I need to find that out, because apparently it should be?

[Kirk Maldonado]

If employee contributions can be used to purchase employer stock, the sale of the stock must be registered with the SEC. If it isn't registered, you have violated the federal securities laws.

[katieinny]

Thank you! That's going to be my next phone call.