Employer Stock Restricted to Current Employees Only?

[kmhaab]

Can a 401(k) plan sponsor restrict investment in the employer stock fund to current employees only? i.e. require terminated employees to exit the employer stock fund when they terminate employment?

[CuseFan]

I would say no. This is similar to an old scenario where employers automatically moved terminated participant balances into a MM fund. The IRS deemed this a detriment/impediment (don't remember their exact wording) to an employee's consent which invalidated their "voluntary" election to a distribution. That is, you can't coerce someone to take a distribution by treating them less favorably than current employees.

However, if the stock fund is an ESOP, I believe you can limit ownership to employees IF the corporate bylaws restrict ownership to employees of the corporation.  

[ESOP Guy]

28 minutes ago, CuseFan said:

However, if the stock fund is an ESOP, I believe you can limit ownership to employees IF the corporate bylaws restrict ownership to employees of the corporation.  

That rule really applies to distributions since the trust owns the share in the ESOP. 

There is a way in ESOPs to force people out of the shares by doing segregation.  However, ESOPs don't give people investment choice so the logic of that IRS ruling you speak of doesn't apply.   That ruling the example was a PSP that gave people investment direction and forced all terms into a MM fund.   The IRS objected to taking their investment choice away from them. 

I believe this is the Rev Ruling CuseFan speaks of.

http://www.unclefed.com/Tax-Bulls/1996/RR96-47.PDF

[kmhaab]

Thank you both.

To make sure I understand correctly, if the employer stock fund is an ESOP, there would be a way to force terminated employees out of the fund, correct?

[ESOP Guy]

As a rule "yes" but most ESOPs don't allow for participant direction.   In almost all ESOPs the trustee directs all the investments.  That ruling by the IRS that is the issue with them.  The plan was taking away participant's ability to direct their investments.  So if you had an ESOP with participant direction I might have to think about it harder.  

[QDROphile]

The IRS informal guidance on this is fairly well understood.  It has a lot of moving parts, including the "segregation" and participant-directed investment feature mentioned by ESOP Guy.  To illustrate the "lot of moving parts" aspect, one approach is to have the non-stock ESOP account of former employees maintained in a 401(k) plan to achieve the segregation and investment standards.  There are some other hooks, too, relating to the ESOP distribution rules.  The answer is that it can be done, but it is complicated and is not susceptible to a short description in this forum.  From where you stand, it appears that the ESOP would have to be amended and lawyer who is hired to assist with the amendment can work the sponsor through the options and maze to determine first if the sponsor has the stomach and the pocketbook to proceed with implementation.