The ESOP Diversification rules provide that an ESOP must allow qualified participants to diversify a portion of the employer securities held in their account. A “qualified participant” is a participant who has completed at least 10 years of participation in the plan and has attained age 55.
A “qualified participant” must be allowed to choose to diversify up to 25% (on a cumulative basis) of the total number of shares of Company Stock acquired by or contributed to the Plan that have ever been allocated to their Company Stock account during the first five years of the Eligible Period and up to 50% (on a cumulative basis) of the total number of shares of Company Stock acquired by or contributed to the Plan that have ever been allocated to their Company Stock account in the last year of the Eligible Period.
IRC Section 401(a)(28) requires that eligible participants must be given an election to diversify during the first 90 days of the plan year and the elected amount must be distributed within 180 days after the close of the plan year. (For example, for plan years ending 12/31/2011, diversification elections should be processed by 6/28/2012.)
Diversification Election Options
The ESOP plan document will indicate how diversification elections can be processed. The available options are as follows:
Distribute cash that the participant can take as a taxable distribution or roll over into another retirement investment vehicle.
Distribute stock to the participant that can be put back to the company for cash, which can also be a taxable distribution or a roll over into another retirement investment vehicle.
Have the ESOP offer at least 3 investment options for the participant to invest their diversification proceeds.
Transfer the diversification election amount to another plan sponsored retirement plan, such as a 401(k) plan, that offers at least 3 investment options for the participant to invest their diversification proceeds.
Diversification of employer securities in an ESOP is a plan qualification requirement. Make sure you read your ESOP plan document to confirm you are complying with the diversification election options as written for your plan. Your ESOP TPA and consultant should be assisting you with the ESOP diversification process.