Diversification

[Lori H]

We hardly ever see diversification, but a couple of participants are inquiring about it. What if they elect to diversify? The plan doc states that the plan may satisy the requirements by offering at least 3 investment options to the participant. In addition if the participant consents, the plan may DISTRIBUTE the portion of the ESOP stock account covered by the electionto the participant within the 90 day period after the election is made. So I interpret this to mean the participant can keep their money in the plan, transfer a percentage of it out of employer stock into another investment of which they must be given 3 choices OR they can elect to have that percentage distributed to them. My other concerns center around how the assets are held (I am assuming they must be segregated to a specific individuals account, but still held by the ESOP as an asset) and how do we purchase those assets? Can the participant contact a broker, tell me to send the broker their money, and then hold it for them by the ESOP or does it work some other way?

Thanks in advance.

[A Shot in the Dark]

Lori:

Should the ESOP Plan Trustee choose to satisfy the diversification requirement by providing alternative investment options within the Plan, it is the Plan Trustee that must develop the investment policy, select the appropriate investment choices and products. Regarding alternative investment options, the rules are no different than one might find for any other defined contribution qualifed retirement plan.

That is why providing a distribution to the eligible participant equal to the diversification requirement is an option used by many ESOP's. The diversified amount is eligible for rollover, etc.

[Lori H]

so the trustee sets up an account in the name of the plan, allocates the diversified amount to the investment options chosen by the trustee and the participant directs the investments among the options. Alternatively, the plan and at the participants election, can distribute the diversified amount to the participant and report it as such on the 5500 and 1099. Yes?

[A Shot in the Dark]

Allowing the participant to self direct amount the alternative investment choices selected by the ESOP Trustee is perfectly acceptable.

Regarding the distribution of the diversified amount; yes, the distribution is reportable via a 1099 and the other applicable forms and yes the distribuiton is reported on the Form 5500 applicable financial schedule, H or I no different than any other plan distribution.

[RLL]

If there's a 401(k) plan at the company, a transfer of assets to that plan could be used to satisfy a diversification election. Very few ESOPs allow for diversification accounts within the ESOP. Most provide for a distribution or a transfer to a 401(k) plan.

Whatever options are to be made available to electing participants must be specifically provided for in the ESOP plan documents, as well as in the SPD. It appears that the plan document you're dealing with here allows for diversification within the ESOP .... bad planning, bad drafting, bad advice.

Looks like you'll need plan amendments here. I suggest that you seek advice from competent counsel who has real experience with ESOPs.

[Lori H]

rll,

why do you consider diversification inside an esop a bad idea? I'm curious.

I think in this particular plans instance and in order to simplify things, the trustee is going to distribute to the participant the cash value of the diversified stock. Wouldn't diversification in future years apply to only on the growth from one year to the next and not the entire account?

[QDROphile]

Why create extra infrastructure and administrative and fiduciary burden under the plan when better alternatives are available?

[GMK]

I agree with the comments posted.

1. The ESOP can add accounts for individual participants (to accept their diversification distributions). It's just more work for the ESOP - setting up "reasonable" options requires some research and on-going monitoring and there are more records to keep.

We set up a 401(k) apart from the ESOP and find that many of those who diversify like to roll it into their 401(k) accounts. Others prefer to roll it into an IRA they set up separately from the company sponsored plans. Some take the cash (and get hammered with taxes).

2. Future diversifications are not necessarily based only on the latest year's growth. Generally, ESOP diversifications can be elected for each and any of the 6 consecutive plan years in the Qualified Election Period (QEP). The participant can elect to receive a diversification distribution of up to a percentage (25% or 50%) of the stock contributed to the participant's account since 1986, less previous diversification distributions. In the first 5 years of the QEP, the percentage is 25%. In the 6th and last year for which a participant can elect a diversification distribution, it is 50%. So, for each year you calculate 25% (or 50%) of the post 1986 stock and subtract previous diversifications, if any, to determine how much is available for a diversification distribution that year. A spread sheet helps.

Good luck.