Exceptions for ESOP Loans
Now it sounds simple, right? Well for better or worse, there are a number of exceptions to the timing rules above that an ESOP administrator needs to understand and monitor.
Financed Securities Exception
IRC Section 409(o)(1)(B) allows an ESOP to implement a special delay of distributions related to the stock balances in a terminated participant’s account that were purchased with an exempt loan. A distribution of those shares does not need to occur until the close of the plan year in which such loan is repaid in full.
While this clause can be applied to all terminated participants, plan documents normally limit it to terminated participants other than retired, deceased and disabled participants. Most plan sponsors do not want to apply the extra delay for retired, deceased, and disabled participants. The ESOP plan document must clearly and specifically indicate which terminated employees this provision applies to in order for the financed securities exception to be applicable in the administration of the plan.
Required Minimum Distributions (RMDs)
ESOPs must comply with the Required Minimum Distribution rules of IRC Section 401(a)(9). These rules set the final deadline by which ESOP distributions must begin, and generally, these rules are to ensure that participants actually use ESOP benefits for retirement.
General Qualified Plan Distribution Requirements
ESOPs must comply with the distribution commencement rules of IRC Section 401(a)(14). These rules apply to the commencement of benefits of all qualified retirement plans and cover conditions including:
- Participant age and plan retirement age
- Participant years of plan participation
- Termination of service with the employer
- And other important details
Death Benefits 5-Year Rule
As stated in IRC Section 401(a)(9)(B)(ii), in some cases the entire interest of the deceased participant must be distributed to the beneficiary within 5 years after the death of the participant. This requirement supersedes the Financed Securities Exception, which is another reason to not use the loan delay option for distributions to deceased participants.
A Complete Written Plan is an ESOP Best Practice
Flexibility can be built into the timing of ESOP distributions. Creating a written distribution policy to complement the plan document and further define the timing of distributions to plan participants is a best practice and a good way to communicate the current distribution process to the ESOP participants. Promoting awareness in this way is consistent with ESOP cultural values of employee ownership.
Whether or not you already have an ESOP distribution policy in place, it’s important to carefully document the timing, form, and method to demonstrate that you operate your ESOP in a nondiscriminatory way. Our eBook, ESOP Distribution Policy: Timing, Form, and Method, can help you get started following this important best practice. Just click the link below to get started.