ESOP diversification transfer to 401(k) Plan

[AJ North]

We have a client with an ESOP plan that indicates that if a participant chooses to diversify, the amount is transferred in cash to the 401(k) plan of same plan sponsor. The participant cannot elect to receive the diversified amount as cash to rollover elsewhere. Question: how should the 401(k) plan recordkeep for the transferred amount? My feeling is that this should be considered an elective plan transfer not a rollover. Do we need to worry about any cutbacks and mirror any optional forms of benefits and withdrawal provisions that may be more favorable in the ESOP?

[ESOP Guy]

I don’t believe it is a rollover either. I have always recommended to my client’s to have their record keeper make this money its own source on their system. I think it is best if you can track this money. I don’t recall ever having a client were the ESOP money has any meaningful protected rights to track so not 100% on that question. But don’t forget that money can never buy company stock. May not be an option in the 401(k) plan.

[AJ North]

Thank you for your response ESOP Guy. The plan does not have an employer stock option in the 401(k) plan, so that's not an issue. I will review and compare the withdrawal options and benefit forms to carry over. Plan sponsor is "forcing" diversification, so that will be another issue we will address with the client.

Thanks again.

[Guest cbclark]

Thanks for pointing this out. We have been having a discussion about whether it is a transfer account versus rollover, and I was not comfortable with "rollover."

Same scenario: ESOP diversification money is transferred to the (k) plan. Any ideas about what to do with a terminated participant who withdrew all his (k) accounts and in the next plan year is eligible to diversify? We think the participant will want to take the money (his ESOP balance is in the 5 year payout) but what if someone doesn't want to take the distribution? If the amount exceeds the cashout threshold, can't force it out, and if there is no (k) account left, where would it go? We need to amend the plan to deal with this situation and wanted to cover all possible scenarios. Thanks!

[AJ North]

You might want to consider amending the plan and limiting the options available to the participant depending on their employment status. Active participants could be given an option to transfer to the k plan. Terminated participants could be limited to a distribution, this way if the former participant cashed out their k plan account, you wouldn't be bothered with having to reopen it to receive a transfer.

[Belgarath]

I have a similar question. Employer has a plan with ESOP and 401(k) provisions. It isn't publicly traded stock, so it only has the 401(a)(28) diversification provisions. The plan document is a little odd, (at least to my untutored eye, as I don't really deal with ESOP's) and doesn't really address the question of where this money is deposited. The plan apparently currently has only deferral accounts, match accounts, and Stock accounts, but no ESOP "cash" account.

Is it really just an accounting function, so that they deposit this into whatever account holds the match/deferrals, but "tag" it somehow for separate accounting? Or MUST they physically open a separate account?

[ESOP Guy]

I am not 100% sure I understand your question so I am going to ask a couple questions?

1) So this is a KSOP? ie it is one plan with both ESOP and 401(k) provisions not two different plans

2) Is the 401(k) portion daily valued or a balance forward? Most of your question points towards daily, but parts make it almost sound balance forward

3) By separate account do you mean at a whole new account name and number, or just listing another source within whatever account the 401(k) money is in?

I hope I am not being dim witted in reading your question and asking silly questions, but I for one don't feel like I can answer your question until I know more.

[Belgarath]

1. Correct - one plan with both ESOP and 401(k) provisions - not two separate plans.

2. Actually a balance forward.

3. "By separate account do you mean at a whole new account name and number" - yes. And this seems crazy to me, so I'm guessing that they can just do separate accounting.

Thanks for your assistance!

[ESOP Guy]

They can just do separate accounting.

Although is the balance forward 401(k) portion investment trustee directed or participant directed?

I ask because the rules say the person needs to be given three investment choices and with most 401(k) plans being daily and participant directed that isn't hard to do for them.

On the other hand I am not sure I have ever seen a diversification put into a trustee directed 401(k) plan and am UNSURE that would meet the rules. I would have you note I am unsure, not saying it is wrong.

EDIT:

The longer I think about it the more I would say if the 401(k) portion of the plan is trustee directed investments you don't have a valid place to put the diversification amounts. They would have to either allow investment choice, or pay the amounts out of the plan. But at this point I don't have a hard cite other then the rules always talk about 3 investment choices.

[Belgarath]

401(k) portion is trustee directed. If the plan allows the employee the option to take as a distribution, would this satisfy the diversification requirement? Or must such distribution be mandatory? It appears that 401(a)(28)(B)(ii), it is mandatory. Which doesn't make a lot of sense to me, but as I said, I don't really deal with ESOP's.

Thank you for your comments, they have been very helpful in clarifying the issue.

[ESOP Guy]

B(i) talks about the right of the person who MAY elect a diversification

B(ii) refers to only those people who so elect-- you have to distribute or give 3 investment choices.

In your case I would look into the idea of giving people the right to take a distribution if they elect to diversify. If they never elect to take a diversification that is their choice the plan has done its job by simply offering them the option to take a diversification distribution.

And case it isn't obvious the person taking the distribution can either take it as a taxable distribution or put it into an IRA.