ESOP contribution to 401(k)?

[Bill Presson]

I need some help understanding a transaction that has been proposed to a client of the accounting firm that I work for. We don't do any TPA for this client at all. The following is a description of the transaction from the plan's ERISA counsel. The transaction has been recommended by a firm that specializes in ESOP's. This transaction began last week (April 7, 2009). It just doesn't seem kosher to me, but everybody seems to have signed off on it. What am I missing? Thanks in advance for any comments.

The Transaction.

- ABC sponsors a 401(k) profit sharing plan. It has been in place for many years.

- ABC is considering an ESOP. It has not yet been drafted.

- ABC has approximately $800,000 of income which it would like to offset with a deduction.

- The idea is for ABC to make a $800,000 contribution to the 401(k) plan for the 2008 plan year and take a 2008 deduction for this amount. At the time of the contribution, the $800,000 would be allocated among the participants (which may result in a disproportionate allocation in favor of the non-highly compensated workforce due to the highly compensated employees possibly being close to maxing out on annual additions prior to this contribution). This contribution would be "earmarked" or "designated" for later

transfer to the ESOP that is to be formed. I believe the 401(k) needs to be amended to reflect allow this transfer. I have not been involved with this sort of transfer before, but the ESOP person that ABC has been working with seems to think it is not an issue.

- After receiving the transfer of the $800,000, the ESOP would use that money to purchase ABC stock from the current shareholders.

The 401(k) Plan.

- The 401(k) allows the employer to make discretionary non-elective contributions.

- The amount of the contribution appears to be limited only by the deductibility limits (basically 25% of payroll). A contribution of $800,000 would be well under this limit.

- The 401(k) looks like a 404© plan, thus the participants have control over the investments of amounts allocated to their respective accounts. To effectuate the transfer from the 401(k) to the ESOP, I believe we would have to amend the plan to give a named fiduciary or plan administrator the authority to direct the investment of that contribution. Of

course, the fiduciary or plan administrator would then have to make a call as to the prudence of moving from whatever investments are available under the 401(k) plan to the company stock that is the only/primary investment in the ESOP.

[QDROphile]

Huge fiduciary concerns with respect to the transfer from the 401(k) plan to the ESOP. But you got that point. Best to have an independent fiduciary for that decision.

[masteff]

Your search words are "convert 401(k) to esop"... and the answer is yes, you can. You can also have an ESOP inside a 401(k), so a portion of the money in the plan might be converted to ESOP while the rest remains 401(k) money. Is there any rule against the company using recordkeeping codes to keep this specific company contribution distinguishable from other company contributions? no, there isn't anything wrong w/ it (it's just more recordkeeping work).

So the question du jour is not the future ESOP issues but is the amount being contributed to the 401(k) fully allowable and deductible under the current 401(k) and it sounds like you've already answered yes to that.

[Bill Presson]

I guess my biggest concern is that they are amending the plan and creating a brand new source after the end of the plan year. They aren't allocating this in the current non-elective source that existed in the plan on 12/31/08.

[masteff]

I guess my biggest concern is that they are amending the plan and creating a brand new source after the end of the plan year. They aren't allocating this in the current non-elective source that existed in the plan on 12/31/08.

You're focusing on the labels for the sources and not content. If I created a source called "masteff's beer money" but I use it to put non-elective contributions into, then that money is non-elective despite my label. Now, if they call it "ESOP" right now, that's a bit misleading ("future ESOP" might be a bit better), but it's still non-elective contributions and your accounting and 5500 work will reflect them as such... until they actually make the amendment and convert to an ESOP.

Question: I'm confused between your two posts... are they amending in the future or have they amended for ESOP already?

[jpod]

QDRO hit the nail on the head. What is being proposed is a 2009 spin-off of a piece of the 401(k) plan. So far, probably no problem. Then, the spun-off plan holding "old money" is converted to an ESOP and the assets ($800,000?) used to buy stock from the Company, or at least that's my assumption. The latter is a fiduciary act which will likely be judged very harshly by DOL and or IRS because it is old money that will be funding the stock acquisition, rather than new money.

[Bill Presson]

I guess my biggest concern is that they are amending the plan and creating a brand new source after the end of the plan year. They aren't allocating this in the current non-elective source that existed in the plan on 12/31/08.

You're focusing on the labels for the sources and not content. If I created a source called "masteff's beer money" but I use it to put non-elective contributions into, then that money is non-elective despite my label. Now, if they call it "ESOP" right now, that's a bit misleading ("future ESOP" might be a bit better), but it's still non-elective contributions and your accounting and 5500 work will reflect them as such... until they actually make the amendment and convert to an ESOP.

Question: I'm confused between your two posts... are they amending in the future or have they amended for ESOP already?

As of 12/31/08, the 401(k) was in place and had been for a number of years. In April 2009, the 401(k) is amended to add a new source to accept the "earmarked" ESOP contribution. In summer 2009, the new ESOP is going to be created and the $800k will be transferred from 401(k) to ESOP. Then, the $800k will be used to purchase stock.

And, fortunately, we aren't doing the TPA work on this plan. That's someone else's fun time.

Thanks.