Merging a 401(k) Plan and an ESOP

[Guest smithee]

Can anyone point me to articles on the internet or elsewhere which discuss issues relating to the merger of a 401(k) plan and an esop into a ksop?

[BeckyMiller]

Go to http://www.nceo.org. They have quite a bit of information about KSOPs - the combination of an ESOP and a 401(k) plan.

[RLL]

smithee ---

You may also want to check with The ESOP Association at http://www.esopassociation.org and the Foundation for Enterprise Development at http://www.fed.org for additional information.

[Guest JTM]

If I could ask a followup question.....

If a company chooses to create an ESOP within their 401(k) plan, creating a kSOP, what is the definition then of a qualified participant in terms of diversification?

Is the '55 years of age and 10 years of participation in the ESOP' limited to the participation in the true ESOP portion of the plan, or does the participation in the 401(k) plan count toward that?

Any direction would be appreciated.

[RLL]

Hi JTM ---

The ESOP diversification election under IRC section 401(a)(28)(B) is limited to that portion of a participant's account that is represented by shares of employer stock allocated under the ESOP portion. In counting "years of participation" for this purpose, it is possible that the IRS would consider the 401(k) plan to be a "predecessor plan" and require "tacking" of years under the ESOP....but this is an unclear area. In designing the ESOP, however, the employer may desire to specifically exclude the pre-ESOP years when drafting the plan document. If the ESOP then receives a determination letter from the IRS with such an exclusion, the pre-ESOP years can be disregarded.

[MWeddell]

Going back to the original post (yes, I know it's kind of old) ...

Be aware that the legislation that the House passed recently imposes a new diversification right after contributions have been in the plan for three years. The ESOP exception only applies if it's a stand alone ESOP not part of a 401(k) and 401(m) plan. In other words, merging a stand-alone ESOP funded with employer nonmatching contributions into a 401(k) plan might turn out to be a bad idea from the employer's perspective if this bill becomes law.

[RLL]

Hi MWeddell ---

The "ESOP exception" to the expanded diversification rights in the House-passed bill also applies to all ESOPs of closely-held companies (whether "stand-alone" or not).

[mbozek]

Doesn't a stand alone ESOP also get the benefit of the tax deduction for reinvested dividends under EGTRRA?

[RLL]

Hi mbozek ---

The dividend deduction provisions of IRC section 404(k) are available to a C corporation that maintains any statutory ESOP under IRC section 409(a) or IRC 4975(e)(7). Such ESOP may be a "stand-alone" ESOP....OR it may be combined or coordinated with (or be a portion of) some other qualified plan under IRC section 401(a), including a 401(k) plan.

The dividend deduction under section 404(k) is available for reinvested dividends only if the ESOP participants may elect to receive such dividends in cash.