5A
The ESOP Association California/Western
States Chapter Conference
Paradise Point Resort, San Diego / October 5-7, 2011
Benefit Distribution Basics:
Time for Take Out!
Session 5A
Randy Shrake
Blue Ridge ESOP Associates
Office: (360) 896-4815
[email protected]
Debra Stoll
Principal Financial Group®
Office: (515) 783-4461
[email protected]
Laurie Salter
BMD – Building Materials
Distributors
Office: (209) 744-4473
[email protected]
Overview
•  Some of the Basics
•  What is a Distribution Policy?
–  Distribution Timing
–  Distribution Methods
–  Forms of Distribution
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Satisfying the Put Option
Factors to Consider
What Can You Change?
Missing Participants
Overview of Tax, Administrative Issues and Repurchase
Obligation
•  Participant Communication
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Some of The Basics
•  General Code/ERISA rules for distributions
–  Retirement
•  Within 60 days of the close of the plan year in which the
latest of the following occurs:
◦  Earlier of age 65 or normal retirement age
◦  10th anniversary of 1st year of participation
◦  Termination of service
–  Required minimum distributions
◦  Age 70½
◦  Death
•  Accelerated ESOP distribution rules
–  Apply to stock acquired by an ESOP after 1986 (anybody
have any pre-86 stock?)
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What is a Distribution Policy?
•  The provisions of the plan document that describe when
and how distributions will occur, or
•  In some cases there is a separate distribution policy
document that spells out when and how distributions will
occur
–  Offers more flexibility
–  Avoids plan amendments
–  IRS is requesting document as part of the determination
letter submission
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Basic Elements of a
Distribution Policy
•  Timing – When distributions begin
•  Method – Lump sum or installments
•  Form – Cash or stock
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Distribution Timing
•  Benefits attributable to post-1986 stock must be made
available for distribution no later than
–  End of plan year following year the participant left due to
retirement, disability or death
–  End of 6th plan year following year of termination of
employment or termination for another reason (unless
reemployed)
–  Except that plan may delay distribution of shares purchased
with an exempt loan until the end of the year in which loan is
repaid
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Distribution Timing
•  Leveraged ESOP exception
–  Applies only to shares acquired with the ESOP loan
•  General Code/ERISA rules may require distribution before
the ESOP loan is repaid
•  Consent required
–  Before plan retirement age (or age 62, if the plan retirement
age is earlier than 62) if vested balance exceeds $5,000
–  If vested balance exceeds $1,000 – automatic rollover rules
apply (unless plan has reduced cash-out amount to $1,000)
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Timing Decisions
•  When does the distribution begin for death, disability,
normal retirement age (termination required?), other,
and QDRO’s?
•  Will distributions be delayed until ESOP loan is
repaid?
–  NLT 60th day following retirement if participant has at
least 10 years of participation
–  Apply wait for death, disability and retirement?
•  Do any loan covenants restrict timing?
•  Does the size matter?
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ESOP Distribution Methods
•  Lump Sum
•  Installments
–  Over a period not exceeding 5 years (up to 6 installments)
•  Extension for large balances
–  One additional year (but not more than 5 additional years) for
each $195,000 or fraction thereof by which such balance
exceeds $985,000
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Distribution Method Questions
•  Will the plan make distributions in a lump sum or
installments?
•  Installment distribution or installment repurchase?
•  Does size matter?
•  Minimum installment amount?
•  Will the plan differentiate based on the event triggering the
distribution?
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Forms of Distribution
•  Cash
•  Stock – participant has right to demand distribution in
employer securities
–  Exceptions
•  Substantially employee owned: Charter or bylaws restrict the
ownership of substantially all outstanding shares to
employees or to the ESOP
•  S Corporation
•  May still distribute stock with the requirement that it be
immediately sold to the company or ESOP
•  Put Option
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Form Questions
•  Will distributions be in stock or cash?
•  If cash, where will the cash come from?
•  If stock, who will repurchase the shares; the
the Plan?
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Other Items to be Addressed
•  Conversion of terminated participant accounts to other
investments
•  Events occurring after termination
•  What does your plan/policy say about force out
threshold:
–  Installments (20% per year? subsequent delay at
option of participant?)
–  Lump sum (statutory amount or other?)
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Satisfying the Put Option
Two traditional methods to handle repurchase liability
and satisfy the Put Option
•  Redeem shares
–  Participants receive a distribution of shares
–  The shares are sold back to the company
–  The company’s equity value declines, but no dilution to
the remaining shareholders’ per share value
–  The ESOP’s ownership percentage decreases (if less
than 100% ESOP-owned)
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Satisfying the Put Option
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Recycle shares
–  The ESOP purchases shares from departing participants
–  Cash contributions, dividends/S distributions, or existing plan
assets fund the purchases
–  The shares are reallocated to the other ESOP participants
–  ESOP ownership percentage remains the same
–  The company’s equity value declines and per share value is
diluted
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Factors to Consider
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Plan provisions, policies, procedures?
Value of stock if redemption (timing)
Benefit level
Financial statement impact
Have and have not issues
Tax impact to company
Input from ESOP Trustee? Administrative Committee?
Participant expectations?
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What Can You Change?
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According to the statute:
–  Protected benefits for “rights and features” from reduction of
elimination (anti-cutback rule)
–  ESOP exception
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According to regulations:
–  Single sum or optional forms
–  Cash for stock if employer becomes substantially employee
owned or is an S-corporation
–  Cash for stock if employer securities become readily tradable
Regulations do not address timing other than de minimis
changes
•  Changes must be nondiscriminatory – cannot discriminate in
favor of HCEs
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What About These Changes?
Diversification options (in service only or does it include
inactive participants too? Plan document/diversification
policy)
•  Segregation policy
•  Accelerate installment distributions
•  Changes to distribution policy after someone terminates
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Missing Participants?
Reasonable efforts to locate
•  Convert account to cash
•  Dealing with uncashed checks
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Taxation Issues
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Eligible for rollover
20% mandatory federal withholding
State withholding
Withholding from stock distribution
Net unrealized appreciation
–  Discuss with administrator to make sure cost basis tracked
–  Communicate to participants
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Form 1099
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Administration
Clearly define process
•  Internal and external coordination
•  Review and audit
•  Ask questions
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Participant Communication
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Timing
Clear & concise
Cut-off dates
Reminders
Legal review
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Repurchase Obligation
Distributions = cash (even if stock distribution – unless
publicly traded)
•  Impacts company cash flow if recycling or redeeming
•  Plan early – even if ESOP has outstanding loan
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Questions?
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