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Last week we discussed how the IRS has informally defined ESOP Rebalancing and ESOP Reshuffling in a February 23, 2010 Response to Technical Assistance Request #4. Here are some highlights of the analysis and conclusions of memo:

  • The right to be invested in employer stock is not a § 1.411(d)-4 Section 411(d)(6) protected benefit.

  • Any provision must meet the requirements of a § 1.401-1(a)(2) definite written program and require a § 1.401-1(b)(1) definite predetermined allocation formula. Specifically, any provision providing for the mandatory transfer of stock must have language that "directs the plan administrator as to the number of shares or amount of cash to transfer in or out of plan accounts". The plan must also "state the manner in which the transfers will be effectuated, such as the date of valuation." A reshuffling provision "that affords an administrator discretion to choose which participants will receive or transfer shares violates § 1.401-1(b)(1) of the Regulations"

  • Diversification rights under IRC Section 401(a)(28)(B) - Additional requirements relating to employee stock ownership plans - Diversification of investments and IRC Section 401(a)(35) - Diversification requirements for certain defined contribution plans include "a participant's right not to have shares diversified pursuant to such sections mandatorily transferred back into his or her account." Rebalancing or reshuffling does not violate the diversification regulations as long as the provisions "preclude shares diversified" from being "mandatorily returned to participants' accounts". In other words, the plan may not mandatorily reinvest a participant's account in stock after the participant has diversified those shares.

  • The right of each participant to have or not have a particular form of investment is a plan right or feature subject to the current and effective availability requirements under § 1.401(a)(4)-4 Nondiscriminatory availability of benefits, rights, and features.

    • Rebalancing – "Rebalancing, which treats all participants the same, will not raise issues of current and effective availability."

    • Reshuffling – A plan provision "providing for the transfer of all employer securities from plan accounts of terminated employees" does not raise issues of current or effective availability because terminated employees comprise a coverage group under § 1.401(a)(4)-10 Testing of former employees. A reshuffling provision "will not fail to satisfy § 1.401(a)(4)-4 in form merely because it imposes age or service conditions on the availability of an investment option."

  • Reshuffling provisions must comply with § 1.411(a)-11(c)(2)(i) Restriction and valuation of distributions - Consent and "not impose a significant detriment on a participant who does not consent to a distribution" and provide for sufficient investment options:

    § 1.411(a)-11 Restriction and valuation of distributions.

    (2) Consent. (i) No consent is valid unless the participant has received a general description of the material features of the optional forms of benefit available under the plan. In addition, so long as a benefit is immediately distributable, a participant must be informed of the right, if any, to defer receipt of the distribution. Furthermore, consent is not valid if a significant detriment is imposed under the plan on any participant who does not consent to a distribution. Whether or not a significant detriment is imposed shall be determined by the Commissioner by examining the particular facts and circumstances.

    The memo cited Revenue Ruling 96-47 and provide more details:

    Accordingly, A plan providing participants with the option of an immediate distribution would need to have language that preserves sufficient investment options in order to ensure that the loss of the employer stock investment is not a "substantial detriment". For example, the plan might offer three alternative investment options such as described in Code Section 401(a)(28)(B) or might offer other choices that include a life-cycle fund or targeted-retirement-date fund. Since ESOPs and stock bonus plans may provide for the option of an immediate distribution upon termination of employment, we believe that it is appropriate to request language porviding for sufficient investment options.

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