Repurchase Obligation Factors: Plan Document and Distribution Policy

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Thu, Oct 14, 2010
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We recently started a discussion on the Interrelationship Between Stock Valuation and the Repurchase Obligation. One of the important assumptions used in preparing a repurchase obligation forecast is your Distribution Policy. Here is a quick summary of the various ESOP distributions 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 a 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 distributions are paid in the form of cash or shares and whether the method of distribution will be lump sum payments or installments.

While 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 manage the cash flow of the company and to manage the contribution level and future repurchase obligation. It is essential that the correct distribution policy is used when projecting your future repurchase obligation.

After reviewing the results of your repurchase liability study you may decide to run a different scenario using an alternate distribution policy. A change in distribution policy could significantly change your cash flow and company projections now and in the future. This is why the distribution policy is a key component in understanding the interrelationship between the stock valuation and the repurchase obligation.

Topics: ESOP, Repurchase Obligation, employee stock ownership plan

Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

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