Diversification & Distributions Beyond Statutory Requirements & Trends

Transcription

1 Diversification & Distributions Beyond Statutory Requirements & Trends Carla Klingler, Client Relations Swerdlin & Company (678) Renee M. Stadtmueller, Director Blue Ridge ESOP Associates Phone: (434) ext ACTUARIES AND EMPLOYEE BENEFITS CONSULTANTS New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

2 AGENDA 1. Diversification Statutory Requirements Newest IRS/DOL Guidance Listing of Required Modifications (ESOP LRM) Trends 2. Distributions Statutory Requirements Newest IRS/DOL Guidance Technical Advice Memorandum ( TAM 4 ) Trends 3. Discussion: Diversification Elections and Consent to Distribution are participant investment decisions. Plan design and policy changes are investment decisions by plan fiduciaries. New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

3 Diversification Statutory Requirements Newest IRS/DOL Guidance Listing of Required Modifications (ESOP LRM) Trends New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

4 Diversification Statutory Requirements IRC section 401(a)(28) and Basic Guidance IRS Notice Has not been updated since 1988 (until NOW?) Contains procedural requirements that have been recognized by the ESOP industry as unworkable with closely held ESOPs Technical Assistance Requests ESOP Document provisions Many just mimic the notice requirements Some additional definitions may be provided New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

5 Diversification Stand Alone ESOP Private Company IRC 401(a)(28)(B) Calculating Amounts Eligible for Diversification: Required ONLY for company stock acquired by the ESOP after December 31, Amounts are Cumulative up to 25% of eligible stock over the first 5 Election Periods, then up to 50% in the 6 th and FINAL Election Period (calculated on cumulative formulas). New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

6 Diversification Stand Alone ESOP Private Company IRC 401(a)(28)(B) For Fiduciary compliance, Diversification Policy must offer one of the following options: 1. Offer at least 3 investment options within ESOP 2. Offer at least 3 investment options in another qualified plan (the company 401(k)) 3. Distribute directly to participant (may choose IRA rollover or taxable distribution). New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

7 Diversification Stand Alone ESOP Old Interpretation Requirements: Age years of plan participation Election Periods : There are 6 Election Periods for each participant that begin on January 1 through March 31 (90 days) of every plan year. The first Election Period starts January 1 following the date a person meets the requirements. Timing: Election forms must be provided to eligible participants during each Election Period to make elections during that 90-day period, and if elected, assets must be diversified within 180 days of the close of the plan year. New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

8 Diversification Operational Procedure OLD Timing for Notice & Execution (assume 12/31 Plan Year End) Election Period begins Jan 1 and ends March 31. Send out preliminary Election forms. Participant must make election by March 31 (within 90 days) after end of plan year in which they become eligible to diversify and each of the next 5 years. Participant may revoke, modify or submit new diversification election any time during 90-day election period. Distribution/transfer elections must be completed by June 30 (within 90 days after end of participant s 90-day election period). When the stock price is available, account balances are updated, and eligible shares for Diversification are determined, real numbers are communicated to participants and final decision is made timing may or may not be compliant with IRC 401(a)(28) provisions New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

9 Diversification New ESOP LRM 5 Guidance Same rules as old interpretation of IRC 401(a)(28) regarding compliant options & calculations What IS NEW? (assume 12/31 Plan Year End) Defines Annual Election Period as a minimum 90 period that begins on Jan 1 and ends on March 31; HOWEVER, END date CAN be extended until the date that the value of the shares are communicated to participants. When the stock price is available & account balances are updated, Diversification election forms are provided to eligible employees with real numbers to make their elections. The END Date of the Election Period is set to accommodate Distribution statutory and practical requirements based on the date Diversification benefits are COMMUNICATED to participants Distribution/transfer elections must be completed within 90 days following the established END Date. Diversified shares are subject to put option rights but NOT to the demand to take the stock. Diversified shares cannot be reinvested into company stock except at Participant s election 9 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

10 Diversification New ESOP LRM 5 Guidance (assume 12/31 Plan Year End) Election Period begins Jan 1 each year all other dates are discretionary or contingent! Example of new procedural timeline: June 1: Appraisal is completed & Diversification amounts are determined. June 15: Diversification Notices are received by Eligible Participants. July 31: Company sets the timing for Election Period to END deadline for election forms to be returned. October 29: (90 days later) Deadline for shares to be diversified. 10 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

11 Diversification Current Trends Beyond Statutory Requirements - Amending the Plan To USE ESOP LRM 5 provisions, Plan must be amended by year end. Other changes to consider: Changing the criteria for Qualified Participants Amending definition of Qualified Participant Old: A Participant age 55 with 10 Years of Participation New: An Employee age 55 with 10 Years of Participation Amending definition of Year of Participation Old: A Participant with an account balance in the Plan New: An employed Participant with an account balance in the Plan New: A benefiting Participant eligible to share in the allocation of Employer contributions and forfeitures 11 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

12 Diversification Current Trends Beyond Statutory Requirements - Amending the Plan Plan Sponsors are incorporating more flexible or expanded diversification provisions. Since they are outside of the statutory requirements, they are technically in-service withdrawals for those still employed. Examples of Plan Design changes: Permit diversification beyond the six year statutory period Permit diversification earlier than Age Years of Participation Or Both May allow diversification % greater than 25/50 May allow diversification of pre-1987 shares 12 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

13 Diversification Bubbles Sample Calculations for all 6 Election Periods Demo Assumptions: a) This demo shows just an individual Bubble, not the bigger problem of the first Diversification group that arises when the plan reaches the 10-year mark and moves as a group through the first 6-year election periods. b) New shares added to the account ( additions ) are the same each year c) Participant is electing to Diversify the max shares each year d) No change in FMV per share 13 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

14 Diversification Current Trends Beyond Statutory Requirements Policy Changes Many Plan Sponsors are being more specific in the Plan document regarding distributions resulting from diversified shares. Diversification for Active (employed) Participants Automatic rollover to 401(k) plan Renewed interest in directed investment funds within ESOP Diversification for Terminated Participants Rollover to IRA or another qualified plan Taxable 14 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

15 Diversification Remaining Issues Establishing Practical External Policies Guidance from LRM indicates that stock allocation methods must preclude diversified shares from being returned to accounts. Is the practical affect on Allocation formula plan provisions covered in the written Diversification Policy? A participant could be eligible for both a normal distribution and diversification. Is the compliance method covered in the Plan Document or written Distribution Policy? Compliance or discrimination issues may arise when a fiduciary is redesigning plan benefits outside of statutory requirements. Are the enhanced benefits discriminatory under IRC 401(a), i.e. do they favor HCE s? Plan Document provisions and operational policies must always be in agreement. Must determine how changes are authorized and documented for continued qualified plan compliance. 15 New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

16 Distributions Statutory Requirements Newest IRS/DOL Guidance Technical Advice Memorandum ( TAM 4 ) Trends New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

17 Distribution - Timing Retirement, death or disability End of the plan year following the plan year in which the event occurs Other termination End of the sixth plan year following the plan year in which employment terminates. New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

18 Distribution - Method Lump sum Installments Over no more than 5 years with an additional year for each $215,000 for balances that exceed 1,080,000 Must occur in substantially equal series of installments Not less frequently than annually New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

19 Distribution - Form Cash Stock Exceptions Charter or bylaw provision that restricts stock ownership to the ESOP or current employees S Corporation (may still distribute stock subject to the requirement that the shares are immediately resold to the plan sponsor or the ESOP) Banks New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

20 Distribution Policy Establishes when and how distributions will be made Congruent with the terms of the plan, but generally more specific May be modified from time to time Considers the company s strategic objectives and long-term goals for the plan New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

21 Distribution Policy Considerations Analyze Repurchase Liability Study Review short and long-term cash flow needs Consider benefit levels Evaluate the impact of various strategies on ESOP ownership and valuation Determine impact on 409(p) testing and contribution limits Analyze HR considerations New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

22 Reshuffling/Segregation What if your terminated participants do not want to take a distribution? Conversion of terminated participants accounts to cash Typically use cash of active participants to buy the terminees shares Redemption of shares with an updated valuation is also an option New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

23 Reshuffling/Segregation The provision must be in the plan document and should include the following items: Timing of segregation Total account balance or vested account balance Process to segregate if there is not enough cash to segregate all in full Pro-rata Based on termination date New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

24 What is TAM 4? Technical Advice Memorandum in response to Request for Technical Assistance April 3,2009 regarding the use of Segregated Accounts (aka Reshuffling ) Addressed several Fiduciary concerns Does it un-do previous allocations per plan document? Does it violate the statutory Diversification requirements? Is it truly a trust investment or just book-keeping? Does it provide a significant detriment under IRC 411(a)(11) that prohibits fiduciaries from removing the participants rights to a materially different risk in decision to consent to a plan distribution? New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

25 What is TAM 4? Practical Guidance & Clarifications from TAM Defined Reshuffling as the mandatory transfer of employer securities into or out of plan accounts. The transfer must meet the benefits, rights, and features test of Sec 1.401(a)(4) Defined required language, plan document must state: Method - How the plan administrator is to determine how much cash and how many shares to transfer. Timing - Must identify the date of the valuation to be used Compliance Treating Terminated Participants as a group for Reshuffling purposes does NOT violate Sec 1.401(a)(4)-10 regarding availability in form and is also possible to include age and service requirements, but NO discretion to choose individual accounts. The right to retain employer securities in NOT a protected benefit under 411(d)(6). Reshuffling provisions cannot cause Diversified shares under 401(a)(28)(B) (and 401(a)(35))to be mandatorily returned to participants accounts. To avoid violation of a significant detriment under IRC 411(a)(11), the segregated account investment policy should consider 3 alternative investment options (per Sec 401(a)(28)(B) or life cycle fund or a targeted-retirement-date fund. New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

26 Diversification & Consent to Distribution is an Investment Decision by a Plan Participant Diversification Election and/or Consent to a plan distribution is a participant s choice. Decision How well is the company stock performing? How is my ESOP account growing compared to the stock market? Do I need the money now? What is my investment timeline? My risk tolerance? What if the company goes bankrupt? Is the professional advice to diversify solid advice in a world gone mad? New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

27 Balancing Participant Investment Decisions with Fiduciary Investment Decisions To retain terminated participants accounts in company stock is a Fiduciary investment decision. How well is the company stock performing? Can cash flow handle accelerated repurchase obligation? Who actually contributed to the stock growth and who is actually benefiting from the investment? Timing of segregation / Total or vested account balance? New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

28 Balancing Participant Investment Decisions with Fiduciary Investment Decisions To retain terminated participants accounts in company stock or to segregate it is a Fiduciary investment decision. What are the Fiduciary risks? What is an acceptable rate of return on other investments Does the policy look like a significant detriment to participants who do not consent to a distribution? What is a fair process to segregate if there is not enough cash to segregate all in full? Pro-rata Based on termination date New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,

29 Carla Klingler, Client Relations Swerdlin & Company (678) Renee M. Stadtmueller, Director Blue Ridge ESOP Associates Phone: (434) ext ACTUARIES AND EMPLOYEE BENEFITS CONSULTANTS New South & Carolinas Chapters Joint Conference - Nashville TN September 20-21,