We have recently discussed the importance of Identifying your Long-Term ESOP Objectives and Developing Accurate ESOP Repurchase Obligation Forecast Assumptions as part of the ESOP Repurchase Obligation process. Today we will look at the significance of the ESOP Distribution Policy. Here is a quick summary of the various Timing of ESOP Distribution rules:
Participants that terminate due to Death, Disability, or Retirement are eligible to being taking distributions within one year after the plan year of termination.
Participants that terminate due to Other Separations of Service will begin within six years after the plan year of termination. However, there is an ESOP Loan Exception that allows distributions to this group to be delayed until the ESOP loan is repaid in full.
Participants age 55 with 10 years of participation are eligible to Diversify 25% of their account for five years. The diversification percentage goes up to 50% in the sixth and final year.
Distributions generally cannot be forced by the company. However, a company can make Mandatory Distributions to terminated participants with an account balance of $5,000 or less. If the balance is greater than $1,000, then any forced distribution must be rolled into a safe harbor automatic rollover IRA. Distributions can also be forced to take a distribution if the participant attains their Latest Commencement Date (the later of age 65, termination from the plan, and attaining 10 years of participation) or is required to begin receiving Required Minimum Distributions (most participants must begin receiving taxable distributions after they reach age 70½ and terminate).
Depending on the plan rules, a plan may pay the alternate payee of a Qualified Domestic Relations Order (QDRO) before the plan participant is eligible for a distribution.
In addition to commencing distributions, a plan may effectively speed up the repurchase obligation if they employ an ESOP cash conversion strategy (aka ESOP Reshuffling) for terminated participants.
You will also have to determine whether the Form of ESOP Distribution will be paid in cash or shares and whether the Method of ESOP Distribution will be paid in a lump sum payment or installment payments.
Ensuring the distribution policy being used for your forecast is consistent with your actual distribution policy is an ESOP Repurchase Obligation (RO) best practice:
Ensure the distribution policy used in your RO forecast is properly reflected in your written distribution policy.
While adoping a written distribution policy is a best practice, all plans that have paid a distribution have adopted some form of a distribution policy. Every distribution policy starts with the plan document and the statutory minimum requirements discussed above and is then modified as needed to meet the objectives of the company, to manage cash flow, and to control the employee benefit level.
After reviewing the results of your repurchase obligation forecast you may decide to run different scenario(s) using alternate distribution policy(s). A change in distribution policy could significantly change your cash flow and company projections (and potentially the ESOP valuation) now and in the future which could have an impact on your other ESOP Repurchase Obligation Forecast Assumptions.