ESOP Distributions: Beyond the Rules

Transcription

1 ESOP Midwest Conference September 10, 2015 ESOP Distributions: Beyond the Rules Presented by: Steve Eide Steve Storkan Gray Plant Mooty Alerus Financial 80 S. 8 th St., # Wayzata Blvd., #120 Minneapolis, MN Minnetonka, MN steve.eide@gpmlaw.com steve.storkan@alerus.com

2 Where do all these rules come from? General Internal Revenue Code rules 60-day rule at retirement Required minimum distributions Rules restricting employer discretion ESOP rules Maximum waiting periods Maximum installment payment periods Put option requirements

3 Where do all these rules come from? NUA (net unrealized appreciation): lump sum taxed as capital gain, if paid after termination, death or disability DOL missing participant guidance Employer-created sources Plan document Distribution policy Summary plan description Distribution forms

4 An amalgamation of great ideas?

5 Or an accident waiting to happen?

6 Mid-Career Termination

7 Mid-Career Termination Waiting period Up to six plan years Plan may delay payment until ESOP loan is repaid (only shares acquired with same loan) Plan may say pre-1987 stock is subject only to general qualified plan requirements Consent requirement If vested balance exceeds $5,000 (or $1,000, if elected by employer) Auto-rollover for >$1,000 to $5,000 cash-outs

8 Mid-Career Termination Form of payment (typical examples) Lump sum up to $25,000 Installments for larger balances over a period not longer than 5 years Is this 5 payments or 6? Hybrid: ESOP pays the greater of $25,000 or normally calculated installment each year May reduce installment period to less than 5 years

9 Mid-Career Termination Administrative and tax issues Rollover notice Early distribution penalty if terminated before age 55 Missing participants Unreturned benefit election forms Uncashed checks

10 Retirement

11 Retirement Waiting period ESOP requirement: payment must begin by plan year following year of retirement (or death or disability) General ERISA requirement: within first 60 days of plan year following retirement (if employee participated at least 10 years) good faith partial payment with later true-up No delay even if loan has not been repaid

12 Retirement Optional extended installments Balances above $1,070,000 Add one year for each partial or whole $210,000 increment Rule may be applied at all times, not just retirement age

13 Retirement Administrative issues How to satisfy 60-day rule if valuation is still pending Consent not required at later of age 62 or plan s normal retirement age ESOPs commonly allow participants to defer distribution after retirement

14 Age 70½ - RMDs

15 Age 70½ - RMDs When must required minimum distributions begin? Generally, April 1 of calendar year after year of attaining age 70½ Not until actual retirement if do not own more than 5% of employer s stock ESOP stock is not counted toward 5% ownership test

16 Age 70½ - RMDs Form of payment RMD rules only require small fractional payment (often less than 4% of account) in first years Plan may only permit payments in normal forms (for example, installments over 5 years)

17 Age 70½ - RMDs Administrative and tax issues Communications about RMDs 50% penalty tax on shortfall Will participant double-up payments in first year? If first payment is taken April 1 of following year, second payment is due by December 31 of same year

18 Death

19 Death Required minimum distributions for beneficiaries Life expectancy rule or 5-year rule? Plan may allow beneficiaries to choose Spouses may be treated differently than other beneficiaries

20 Death Administrative issues Appropriate documentation Proof of death Proof of marriage at time of death (if plan says divorce nullifies designation of spouse) Calculating installments when 5-year RMD rule requires acceleration Multiple beneficiaries

21 Death Administrative issues Trust as beneficiary Must ESOP demand copy of trust before allowing rollover? Or is letter from attorney who drafted it enough? Death of beneficiary Does the remaining benefit go to other beneficiaries or to the deceased beneficiary s estate?

22 Real World Examples

23 ESOP Company #1 50 employee manufacturing company. S. Corp. 100% ESOP Owned. Total ESOP Value - $1.75 million in stock and $250k in other investments Annual Repurchase Liability approx. $200k - $300k Annual ESOP Contribution approx. $350k

24 ESOP Company #1 For all repurchases of stock via distribution or diversification, the shares remain in the ESOP and are recycled amongst all active employees using cash within the ESOP. All distributions for balances over $15,000 are done via annual installments over different time periods depending on the size of their balance. Only shares of stock necessary to fund the annual installment are sold by the terminated participants. The remaining shares stay invested in company stock.

25 ESOP Company #1 For Terminated Participants with Balances Over $200,000 First Year After Termination 1/5 20% Second Year After Termination 1/4 25% Third Year After Termination 1/3 33% Fourth Year After Termination 1/2 50% Fifth Year After Termination 1/1 100% For Terminated Participants with Balances Between $100, and $200,000 First Year After Termination 1/4 25% Second Year After Termination 1/3 33% Third Year After Termination 1/2 50% Fourth Year After Termination 1/1 100% For Terminated Participants with Balances Between $15, and $100,000 First Year After Termination 1/3 33% Second Year After Termination 1/2 50% Third Year After Termination 1/1 100% For Terminated Participants with Balances Under $15,000 A Single Lump Sum in the year following termination.

26 ESOP Company #2 35 employee distributing company. C Corp. and 58% ESOP owned. Total ESOP Value - $2.7 million in stock and $400k in other investments Annual Repurchase Liability approx. $200k - $300k Annual ESOP Contribution approx. $100k

27 ESOP Company #2 For repurchases of stock via diversification the shares remain in the ESOP and are recycled amongst all active employees using cash within the ESOP. For repurchases of stock via distributions the shares are distributed to the former participants and immediately put back to the company (sold). ESOP has shrunk from 68% owner to 58% owner and company is reconsidering its long-time repurchase process.

28 ESOP Company #2 All account balances over $3,500 are distributed via annual installments over a 5 year period beginning the year following a break in service (under 500 hours worked). For Terminated Participants with Balances Over $3,500 First Year following One-Year Break in Service 1/5 20% Second Year following One-Year Break in Service 1/4 25% Third Year following One-Year Break in Service 1/3 33% Fourth Year following One-Year Break in Service 1/2 50% Fifth Year following One-Year Break in Service 1/1 100% Only shares of stock necessary to fund the annual installment are sold by the terminated participants. The remaining shares stay invested in company stock.

29 ESOP Company #3 225 employee manufacturing company. S Corp. 100% ESOP owned. Total ESOP Value - $14 million in stock and $50k in other investments Annual Repurchase Liability recently has been as low as $100k and as high as $500k Annual ESOP Contribution approx. $120k

30 ESOP Company #3 Each year, the first step is to use 100% of the cash within the ESOP for the repurchase of stock via distribution or diversification and those shares remain in the ESOP and are recycled amongst all active employees. For the distribution amounts above the cash within the ESOP, the company redeems the shares from the ESOP and pays cash to the terminated participants. 100% of a participant s vested shares are purchased in the year following the year of termination regardless of the size of their balance and regardless of when that participant receives their distribution.

31 ESOP Company #3 All account balances under $20,000 are distributed in a lump sum in the year following the year of termination. All account balances $20,000 and over are moved out of company stock and into mutual funds that the participant can direct until the 4 th year after termination of employment when they can take a lump sum distribution.

32 ESOP Company #4 150 employee manufacturing company. S Corp. 100% ESOP owned. Total ESOP Value - $27 million in stock and $500k in other investments Annual Repurchase Liability recently has been as low as $1 million and as high as $5 million Annual ESOP Contribution 25% of pay since day 1 of the ESOP. Approx. $1.2 million each year.

33 ESOP Company #4 Each year, the first step is to use 100% of the cash within the ESOP for the repurchase of stock via distribution or diversification and those shares remain in the ESOP and are recycled amongst all active employees. For the distribution amounts above the cash within the ESOP, the company using a combination of dividends and stock redemptions to purchase the shares from the ESOP and pays cash to the terminated participants. 100% of a participant s vested shares are purchased and distributed in the year following the year of termination regardless of the size of their balance.

34 Phased Retirement Distributions The Problem: Valuable employees at or close to retirement age are wanted on a part-time basis for their specialized skills, to train and mentor, or to maintain valuable relationships with customers and suppliers. These same employees may welcome part-time work, but the ESOP distribution rules force them to completely separate from service in order to start the clock on their waiting-period or to receive benefit payments.

35 Phased Retirement Distributions One Possible Solution: Amend the ESOP to define phased retirement: minimum age maximum hours worked limit to certain positions, possibly Amend the ESOP distribution provisions to treat phased retirement as a full termination of employment for purposes of the distribution timing rules. Exempt phased retirement from required suspension of installments upon rehire.

36 Conclusion Every ESOP operates under a combination of all-purpose ERISA payment requirements and ESOP-specific distribution rules, to which the employer may add its own design ideas expanding participant rights. The challenge for ESOP Committees, company officers, HR directors and TPAs is to make sure the rules are consistent across all plan-related documents, forms and explanations and to ensure they are being followed correctly in practice. As time goes by, distribution rules should be reviewed to ensure that they are still appropriate in light of current conditions and company objectives.

37 Questions Steve Eide Steve Storkan Gray Plant Mooty Alerus Financial 80 S. 8 th St., # Wayzata Blvd., #120 Minneapolis, MN Minnetonka, MN steve.eide@gpmlaw.com steve.storkan@alerus.com gpmlaw.com alerusretirementsolutions.com